by Archie M. Richards, Jr., CFP^®
October 6, 2003

Sharon writes, "I'm 59 years old and expect to retire in three years. I have 13 years left on a 15-year mortgage of $135,000 with a rate of 6 percent. I will receive a $50,000 cash settlement from a divorce. The question is, should I invest that money or use it to repay part of the mortgage. My tax bracket is 28 percent; I don't want it to rise further."

With interest of 6 percent, deductible at 28 percent, Sharon, your after-tax interest cost is only 4.4 percent.

Collectively, the Vanguard index funds recommended in my June 30, 2003 column (see www.archierichards.com) should return considerably more than 4.4 percent after tax. I therefore recommend investing the money in those funds rather than repaying part of the mortgage.

I read your email to Bob Walters, Chief Economist of Quicken Loans. He wondered whether you intend to move after you retire in three years. If so, Bob suggests a new mortgage now whose interest rate is fixed for five years at no higher than 5 percent. The closing costs for this "Smart Choice Loan" are low. (See www.quickenloans.com or call 800-784-2536.) The payments during the first five years are interest only. Thereafter, the loan becomes a regular adjustable-rate mortgage with a lifetime cap of 9.75 percent. The higher rate wouldn't affect you at all after your house is sold.

But Bob Walters also pointed out that paying down a portion of your current mortgage or obtaining a new lower-rate mortgage might draw down your interest costs so that you'd be better off taking the standard deduction instead of itemizing. This would exclude you from deducting interest payments. Try to minimize the after-tax costs.

However, these financial considerations should not be your first priority. To the extent you can, choose where you live according to your emotional needs. Your emotions should have priority, not your money.

Murray writes, "I want to invest $10,000 in a Vanguard fund. Which one would give some safety, yet be aggressive enough to make it worthwhile?"

"Aggressive" is a dangerous word, Murray, when applied to investments. The diversified portfolio I recommend (see above) should return slightly less than the stock market as a whole, but with much reduced risk.

If the S&P 500 returns 12 percent a year, as it has since World War II, my portfolio should return something like 11 percent - maybe a little better. (Actually I expect both numbers to be higher during the next decade.) But the volatility of my portfolio should be considerably less than that of the market, making it easier for people to avoid selling their stocks during down markets.

My June 30, 2003 column recommends 9 index funds. But Vanguard charges an extra $10 a year for investments of less than $3,000 in any one fund. Investing $10,000 would incur the charge in all 9 funds. I therefore reduce the diversification to 4 funds and suggest the following:

$3,000 Total Stock Market Index Fund $3,000 Total International Stock Market Index Fund $2,000 REIT Index Fund $2,000 Long-Term Bond Index Fund

The $10 charge would apply to only two funds. The extra $20 is well worthwhile.

(Readers: Sorry, the above advice is incorrect. Vanguard does not permit investments of less than $3,000, except in IRAs. The column dated November 10, 2003, to be posted to this Website in several weeks, recommends $3,500 in the Total Stock Fund, $3,500 in the Total International Stock Fund, and $3,000 in the Bond Fund. It suggests switching from the bond to the REIT fund several years from now.)

Julian asks, "Does Vanguard offer A, B, and C shares? If not, how does the company get paid?"

A, B, and C shares, Julian, are offered only by investment companies whose accounts are sold by brokers. The shares offer various ways for the commissions to be deducted from accounts.

Vanguard doesn't need A, B, or C shares, because its funds are not sold by salesmen. You must take the initiative to contact Vanguard yourself, fill out the application and send it in with your check.

Vanguard does receive management fees, however. For the index funds I favor, these average only 0.38% per year. Like all mutual funds, a tiny portion of the management fee is charged to the fund every day. But selling costs you need not pay.