Hi everybody, welcome to another wise money tools video. Glad to have you with me today. So I had a really interesting conversation the other day was, and it may fit some of your situations. You know, I know a couple of you still have some teenagers at home, maybe you're in your, I don't know, early 40s, late 40s, who knows. But this couple very similar situation had a couple teenagers at home. He's got a really good job pays well has a 401k. And he's funding it to the max. So that's pretty common for a lot of people. They have a fairly good size home, and along with it a really good size mortgages. And this is kind of where our conversation started. They're worried about retirement, and having that mortgage payment hanging over their heads for years and years into retirement.

So we were just kind of casually asked me, you know, should I take the money out of my 401k and pay off my house? And I got to thinking about that, you know, there's so many variables in answering this question that I thought might be a good conversation for us to have. Because some of you might have a very similar, you know, Outlook or trying to figure some things out like that. So let's look at each of these assets, if you will individually. Let's first take a look at the 401k. Now, there's a couple things to note about the 401k. As you know, it's most likely invested in the stock market. And we've had a really good 10 years in the stock market. In fact, I was thinking the other day I was thinking Man if somebody was in their, you know, mid 20s, got their first job started funding their 401k. They really have no idea what it's like to have some kind of a recession or a bear market.

In fact about the worst year we had was right at the end of last year in 2018. The market tumbled and basically lost all the earnings throughout the year kind of turned out to be a breakeven year but still nothing all that devastating. So for a good decade, we've seen this market pretty much be on a decent projector. Okay, so one of the question was, you know, how long is that gonna last I mean is are we gonna be in this situation where the market is just gonna keep on going keep on going for years and years to come? Well, who knows, we may have another year to we may be coming to the end, I don't know. But recessions you know, and bear markets are really a normal part of the economy, we have to expect them at some point.

And they're actually kind of good, we're gonna see a typical recession hit at some point. It's probably gonna take a decent chunk of returns and earnings from a lot of people's 401ks. It's possible when a recession hits that somewhere between two and five years, sometimes even more of all the growth that you had over those years can be wiped out. When that market finally takes a breather and falls back into we'll call it normal territory. And what I mean by normal territory, I kind of look at that Shiller P/E ratio as a good overview, kind of a 30,000 foot overview of where we're at. And currently that Shiller P/E is still over 29, which means investors right now are paying $29 for every dollar of earnings. So as an example, let's just pick a company, let's say Walmart, as our example, let's say they make $1 on a share stock well invested right now are paying $29 for that $1.

Now to again, for perspective the median P/E the median price earnings ratio is closer to 14 or 16 times earnings. So in other words, dollar earned investors pay somewhere between 14 and 16 times as a median. Now let's contrast that to Amazon. Amazon's price earnings ratio is 93 times earnings. Okay, and apples is right around 8. So you can see there's a lot of variance in the different companies out there. But as a whole, the market is looking at a P/E ratio about 29. And that again, is much higher than it's probably gonna be at some point. So when this market does take a fall, it's gonna be who knows, it could be a year or two might even be just a short time. But what often happens is a market over corrects and drives these P/E ratio is even lower than they should be. That's when buying opportunities are plentiful. And that's when we like to become investors.

Okay, so now we look at this 401k. It's probably done very well over the last, you know, 10 years, like we said. When the market finally resets, he's probably gonna take a who knows 15, 20, 30, 50% hit on his account value? How much will that be hard to say. But it wouldn't be far fetched to think that it's gonna have at least a 20 to 30% hit. So let's just say he's got half a million dollars in his 401k. Over these years. He might expect to lose $100,000 or more. Now in 2008, a $500,000 401k dropped to 250,000, or even less, we affectionately called the 401k a 201k because they were literally cut in half for so many people. Okay, so that's the 401k dilemma and what we're looking at, and you know, what's our best move there. Now let's look at the house, he says that they are kind of house poor, in that the mortgage takes up a significant part of their income.

Now, let's not beat up on them too much. But as they probably realize, now they would have been much better off getting into a home that wasn't so burdensome as far as the mortgage payments. Now on the flip side, they live in an area where real estate's been doing well and their home value is growing the promise someday, when they retire, unless they have other investment income, they're probably gonna need to access the equity in their home, just to get through retirement. This might require them to either sell the home to get the equity out, or maybe even do a reverse mortgage to supplement their income. Who knows. Now they may have looked out, and they've got more house and they should have bought but the equity appreciation is building capital and again cash that someday they may be able to use. Now on the downside, if we go back to 2008, this type of home little higher end home is are the types of homes that fell dramatically some lost 50% of their value.

So that could potentially wipe out a lot of their equity that they've had over the years. Now have to understand one concept about equity. If I were to ask you what rate of return is equity get? So many of you would likely answer that it grows about the rate of home values in your area. And that would make sense, right? But if you live in an area, let's just say where home prices are rising by 3% a year, you might say that equity grows at 3% a year. However, it's really wrong. Okay. Equity gets a 0% rate of return every year, every week, every day forever. You say hi, well, how can that'd be my house goes up? Well, let me prove it to you this way. Let's suppose we have two families, they both buy a home for $300,000 on the same day, same neighborhood, same values, okay. One pays cash.

So he has no mortgage, he put the entire purchase price $300,000 into his home. He technically has $300,000 in equity right? Now the other one finances his home 100%. And I know you really can't do that these days. But it's this is just kind of a show my point. So this family technically has no equity as they put no money into the home. Now, in this case, on a $300,000 home this fame, this family's gonna have about a 1500 dollar a month house payment. And then as include taxes insurance, but both families have to pay those costs no matter what. So let's just say that in five years, both homes grow at a average rate of 3% per year. And so now there were $350,000. So both families have increased their net worth, if you will by $50,000. More than obviously they paid for the home. But here's what I want you to see, the equity in their homes actually grew at 0%.

You see the family that paid cash for their home, has a home where $350,000 they grew by $50,000. The family who had no equity in their home also grew by $50,000. You see the amount of equity in their home, or the amount of money they put into it had no bearing on the growth of the home's value, the market price of the home is what drove the equity. The point is own your home free and clear or have a mortgage is really not going to have a bearing on the price or the value of your home. Now, you could say that this family that put $300,000 cash into their home had a rate of return over those five years of 16% total, or about 3% a year. The exact Return of the homes market appreciation, the other families paid 1500 dollars per month for five years. That's a total of $90,000 that they've put into payments.

Now it's difficult to come up with the exact return because the $90,000 was put in over 60 months, not just from day one at 1500 dollars per month. However, the return on investment would be close to 55% or about 11% a year. So the leverage of using OPM, that's other people's money. In other words, having a mortgage actually enhance the return for this family. Now, here's one thing that I'm adamant about. When it comes to paying off your mortgage, I will never tell someone not to pay off their home, no matter how much better it could be by carrying a mortgage. I'm simply pointing out that there are two sides to the story and you have to do what's best for you and your family. Now, going back to our family in this situation, what they did is they might be regretting having such a stifling mortgage payment. What they may find at the other end, though, is that they've built much more equity and a better return on investment by having a mortgage.

So there's always trade offs. I'd prefer to have a low to moderate mortgage, be able to save more money and use your capital to increase your net worth by investing in other opportunities. Which is why we love our banking system, it's a place you can save tax free gives you access to that capital for their investments along the way, when assets or investments go on sale. Okay, so now we have to separate the two assets, we get the 401k, we've got the home, the question comes to me again from this family. Should we take the money out of the 401k to pay off the home and free up the monthly income that they then could save? I think the only way we'll know the perfect answer to this question is to have a crystal ball and see the future. See if the market is going to tank and his 401k is going to lose $100,000 then of course, it'd be really good idea to take that money out now at the peak right?

Even after paying taxes, you'd be better off to have his home paid for with money that he pulled out of this 401k. On the flip side, if he pays off his home, and dumps all that money into his home and then his home value drops. He may never be able to sell it and recover his investment. It's also possible that he's been living in the home long enough that even if it dropped by 20% in market price. His mortgage payoff would be low enough that he could recover what he's put in. For instance, maybe bought his home for $500,000 homes now worth 800. He owes $100,000 on a mortgage, he pulls it out of his 401k and pays it off. So he pays off his home. And then let's say his home dropped to $600,000. Well, he can still recover that hundred thousand dollars that he put in to pay off his mortgage.

Ultimately, he has to determine which scenario poses the most risk for them. If he pays off his mortgage, have a mortgage payment to save each month. That is if he will, sadly, many people soak up that extra money now that they don't have a house payment and put it into their lifestyle. They end up spending more and buying more stuff, which would make the situation even worse. Now, if the market keeps going up, and the home values keep increasing, he's probably better off doing what he's doing. Now, remember, equity gets a 0% return every single year. If the market tanks, they may wish they had pulled money out at the peak and paid off their house. And now they have a mortgage payment that they were making each month freed up again so that they could invest it and hopefully buy things at lower prices.

He and his wife may have this deep down desire to pay off their home no matter what the calculation say. And again, that's a matter of principle and a lifetime goal. There's really nothing wrong with that many people to that even if it's better financially, to have a mortgage. Again, I'll never tell somebody not to do that. The alternative, like I said, is to have a banking system where you can build up your capital thing, you've got options, you have the option to pay off your house, you have the option to be the bank, you have the option to sit on the sidelines when markets are high, then get involved and buy when they go on sell. You have safety liquidity tax advantages, which can add up to more peace of mind and the investing principles that work. Ok. So now see what was posed to me.

By the way, this was at a wedding reception, and we had about 10 minutes to talk, which is why I don't know all the details and specifics. But I wanted to throw this out to you and get your take on it. What would you do? What are your values when it comes to your home and retirement savings? It's a great discussion to have because thousands of families are probably facing a similar circumstance, maybe even you. I think we could come up with a good plan with more if we had more specifics. But the best plan of all is to buy a home with a moderate mortgage, save, save, save, build capital and become an educated investor. Then wait for opportunities to come along. And when you can buy $10 bills for $5. But you have to have a process to build your capital, which again, is why the banking system can work for so many people.

Okay, so that's it. I'm anxious to hear your comments and your question. If you have direct questions, send them to questions at wise money tools.com. I'll try to answer them just as quick as I can. If you want to just get into the conversation, feel free to leave a comment as well and give an idea of what you would do. If you would like a strategy session where we could talk about your specific situation. You can sign up at the time trade link below. Always subscribe and we love to hear from you. That's it till next time. Thanks for joining me. Take care.