### Understanding the Impact of Extra Principal Payments
At the start of each new year, I dive into our budget to see where we can make the most of our money. Initially, this means reviewing bills and finding ways to cut costs, but I also focus on how we can grow any extra money we have.
There are several good choices for using additional funds. Paying off debt can save a lot on interest payments, which is just as beneficial as growing the money. Another option is to invest. Ultimately, one option will offer a higher return than the others.
So, if you find yourself with some extra money in your budget this year, let’s explore a few smart options. For example, I have about $200 per month that I want to allocate wisely. You can use your own numbers and follow along.
### Three Options to Consider
These are the three paths I’m considering:
1. Make extra principal payments on the mortgage.
2. Invest in the stock market.
3. Increase contributions to a 403b retirement account.
Each option has its benefits, so let’s break them down.
#### Option 1: Extra Principal Payments on Mortgage
One of the first things that came to mind was using the extra money to pay off our mortgage early. Paying off your mortgage early saves tens of thousands in interest and can knock years off your payment schedule. It’s a solid way to become a full owner of your home faster.
For instance, if you have a 20-year fixed mortgage at 3.75%, any extra principal payment is like getting a guaranteed 3.75% return on investment. This also applies to high-interest debts like credit cards. Paying them down is akin to getting a 20% return if your card’s APR is 20%.
Also, paying down debt at a fixed interest rate presents a risk-free return, which is hard to find in other investments.
#### Option 2: Investing in the Stock Market
Another idea I considered is investing the extra money into the stock market. Long-term investments can yield around 8% annually, which is more appealing than the 3.75% from paying down the mortgage. Stocks, especially stable, dividend-paying ones, can grow your portfolio and aid in early retirement. This gives you access to funds without age-related restrictions.
However, stocks come with risks. The market can fluctuate, and while the S&P 500’s 10-year average returns can be as high as 19.21%, they can also be as low as -1.38%. So, there’s a risk-reward balance to consider here.
#### Option 3: Increasing Contributions to a 403b Retirement Account
Then, I reconsidered our retirement accounts. My wife’s 403b is not yet maxed out. By increasing our contributions, we’re saving money before taxes are deducted, which isn’t the case with the other options.
In this scenario, the money put into the 403b could assume an 8% return, similar to stock investments. But here’s the catch: since it’s pre-tax money, it feels like you’re saving more without affecting your budget.
For example, while I was considering $200 per month after taxes for Options 1 and 2, this translates to $267 pre-tax in a 403b if I’m in the 25% tax bracket. More money invested upfront can lead to larger returns over time.
### Conclusion: Which Option to Choose?
After considering all three, I decided to go with Option 3 and increase our 403b contributions. While paying off the mortgage and growing a stock portfolio are appealing, the 403b option offers greater growth potential due to tax deferment and investment strategy. This will be the best use of our extra $200 per month.
So next time you’re pondering what to do with extra money in your budget, consider these options. A little extra planning can lead to significant gains over time, making the effort worthwhile.
