The Wall Street Journal-20080202-Green Thumb- Is Mortgage the Best Home for a Bonus-- Stocks Are Hard to Beat- Financials- Retailers Seen As Play on Rebound Hope
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Green Thumb: Is Mortgage the Best Home for a Bonus?; Stocks Are Hard to Beat: Financials, Retailers Seen As Play on Rebound Hope
Full Text (536 words)You've just received a handsome year-end bonus. Congratulations. Now what?
With the market gyrating and real-estate prices tanking, deciding what to do with a windfall isn't exactly easy these days. Anyone carrying high-interest credit-card debt should pay it off. After that, the choices get tougher. You could scoop up some beaten-down stocks or battered high-yield bonds, figuring they'll rebound. Or you could play it safe and pay down your mortgage.
If the slowing economy has you worried, the mortgage option can look attractive. Say you received a $100,000 year-end bonus and have a $300,000, 30-year, 6% fixed-rate mortgage. If you took out the mortgage at the start of 2006 and simply make the regular monthly payment, you'll pay it off in early 2036. If you put the $100,000 bonus toward the mortgage, you'll pay it off more than 15 years earlier, in late 2020.
Paying down the mortgage makes particular sense if you're planning to retire in a few years and want to ditch your house payment before then. Spenders tempted to splurge on a new car or ski vacation might also consider applying the money to the mortgage. It amounts to a forced savings plan.
But it's not the smartest option for many others. For starters, there are tax consequences. If you pay down the loan balance, in future payments you'll be paying less interest, which is tax- deductible, and more principal, which isn't deductible.
After taking the extra taxes in account, a person in the 28% tax bracket would essentially "earn" 4.3% by paying down a 6% loan. If you're in the higher 35% bracket, your after-tax return would shrink to just 3.9%.
A disciplined investor with long time horizons can almost surely beat those sort of returns in the stock market. In all the 20-year periods between 1958 and 2007, the S&P 500's average annualized return was 11.6%, and its worst 20-year annualized return was 6.5%, according to T. Rowe Price Group Inc. Even after paying taxes on those gains, you'll come out well ahead of the mortgage's after-tax cost.
Where to go in the market? Consider industries like financials and retailers, which have been punished amid growing fears of an economic slump -- and could get the biggest bounce if the economy reaccelerates later this year, as many investors expect. Exchange-traded funds focused on such beaten-down stocks include KBW Bank and Consumer Discretionary Select Sector SPDR.
In the bond market, low-yielding Treasurys aren't an attractive alternative to paying off the mortgage, advisers say. But taxable high-yield bonds, which have recently begun yielding substantially more than Treasurys, are starting to look interesting for investors who can stomach some risk. One mutual-fund option: Pimco High Yield.
You might also consider high-yield municipal bonds, which generally offer lower yields than traditional junk bonds but are typically exempt from federal income tax. T. Rowe Price Tax-Free High Yield fund focuses on these bonds.
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Bonus Round
Some pointers on what to do with a year-end bonus:
-- First, pay off any high-interest credit-card debt.
-- Weigh the value of your mortgage interest tax deduction
before paying down your mortgage.
-- Long-term, stock returns will likely outpace the cost of
a low fixed-rate mortgage.
