Potential investment returns -- and risks

We're selling our house and moving into one we inherited. Should we invest the money from the sale in stocks and bonds, or use it to pay off the 3.5 percent mortgage on our second home in North Carolina? My husband is retired and we have very little taxable income.

You haven't mentioned some important factors in this decision, like your ages and what investments you already own. A diversified portfolio that will have to support you for 20 years or more should include both stocks and bonds.

That said, the rule of thumb for this decision is to compare the interest rate on the loan with your potential return in the alternative investment. Let's say you're deciding whether to repay a 15 percent credit card debt or invest in stocks, for example. Paying off the debt is a better idea because it's like earning a risk-free 15 percent guaranteed return -- and you can't get that from stocks.

Let's assume that on an after-tax basis, you're paying 3 percent on the mortgage -- so paying it off is like making a risk-free investment guaranteed to deliver a 3 percent after-tax yearly return. How does that compare to stock and bond returns? Since 1970, stocks have delivered an average annual return of about 7 percent after taxes and investment expenses, and bonds about 3 percent.

Of course, those averages include years of higher returns and years of negative returns. Before making a decision, consider your tolerance for financial loss. Remember, too, that your return on any investment depends partly on what you paid for it. With stock prices currently so high and interest rates so low, many experts predict stock and bond returns over the next 10 years will be below historic averages.

The bottom line When comparing investments, always consider their potential risks as well as their potential returns.

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