Compartmentalize Your Finances

 Love Starbucks? A lot of us do, but try answering this question I recently heard posed by a behavioral finance professor:  “Would you be more inclined to order a latte that was advertised as 95% fat free, or one labeled 5% fat?”  The two $5 drinks are the exact same, however, I would venture to say 99.9% of people (including me) would choose the drink that was advertised as 95% fat free.  Perception is as powerful force in the coffee world as it is in the investment world. Perception can work against you when it comes to savings or it can fuel you. Much of that depends on how you compartmentalize.

The Behavioral Finance of Compartmentalizing

So what does it mean to compartmentalize?  Simply put it is separating two or more things from each other.  In personal finance, separating certain accounts to have individual goals can have a tremendous effect on the likelihood of savings and overall success of the individual’s financial plan.  For instance, one of the most important pieces of a financial plan is maintaining an adequate emergency fund for the dreaded unknowns – such as job loss, unexpected home improvements, medical expenses, etc. (The Center team usually recommends that clients maintain 3 – 12 months of living expenses in a cash account that is not subject to market risk). 

Establish Separate Accounts

If you find yourself constantly transferring funds from your savings to your checking account each month because they are at the same institution and the ease of the transfer is just to easy to resist, consider making a change!  Why not open a savings account at a completely different financial institution and maintain your emergency fund there, knowing this money cannot be touched except for an emergency. 

Give it a Label

Many banks now allow you to name an account and personalize it.  So instead of seeing your account being titled as “Savings” each time you log in, it would read “Emergency fund – don’t touch!”  Adding that “name” or “purpose” to the account has been proven to dramatically increase savings levels and decrease the likelihood of spending out of the account. 

Keep it Simple

Separating accounts for each individual goal in retirement, however, is pretty unrealistic.  Who wants to have 20 different IRA accounts?  At The Center, we like to keep things simple to stay organized and on track.  However, our advisors do encourage clients to compartmentalize in their minds when looking at their overall stock/bond/cash allocation to stay focused and not lose track of the purpose of each type of asset that is held within the portfolio.  Each “bucket” of funds has a purpose and impact on the total portfolio and it is The Center’s job as your trusted advisor team to help you fill each one and utilize them to their maximum potential.  

Nick Defenthaler, CFP® is a Support Associate at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.

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The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.

Deducting Investment Management Fees & Medicare Surtax: Note for Higher Income Earners

 High earners beware! Thanks to the new Medicare Surtax deducting investment management fees becomes even more complicated.

This potentially applies if you are:

• Single earning more than $200,000
• Married filing jointly earning more than $250,000

In a blog last year I explained the grey area of deductibility of investment management fees. In general, investment management fees paid in taxable accounts (such as single, joint or living trust accounts) are a tax deductible expense and reported as a Miscellaneous Itemized deduction on Schedule A of Form 1040. However, this only benefits taxpayers whose Miscellaneous Itemized deductions exceed 2% of their Adjusted Gross Income.

But the new Medicare Surtax further fogs up this grey area. The basic rule is that investment management fees are deductible against the 3.8% Medicare surtax on net investment income.  However, the 2% “rule” still applies, and to further complicate the issue, the deduction amount must be prorated if you have other miscellaneous deductions. 

The good news is that for those working with a professional tax preparer you may not even notice the fog. You will want to continue to provide your tax preparer your yearend tax report from your brokerage firm (such as Raymond James) which contains the necessary information on investment management fees. For those preparing their own tax return, the IRS has stated that they will be providing special IRS forms to assist in the calculation early next year.

As always, if you need help getting through the maze, give us a call. 

Timothy Wyman, CFP®, JD is the Managing Partner and Financial Planner at Center for Financial Planning, Inc. and is a frequent contributor to national media including appearances on Good Morning America Weekend Edition and WDIV Channel 4 News and published articles including Forbes and The Wall Street Journal. A leader in his profession, Tim served on the National Board of Directors for the 28,000 member Financial Planning Association™ (FPA®), trained and mentored hundreds of CFP® practitioners and is a frequent speaker to organizations and businesses on various financial planning topics.

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The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  Please note, changes in tax laws may occur at any time and could have substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters.  You should discuss tax or legal matters with the appropriate professional.

Is This What A Secular Bull Market Feels Like?

 Fall is a wonderful time in Michigan.  The leaves are turning, the Tigers gave us some playoff excitement and football season is in full swing.  Economists and money managers must agree as many have been visiting the state giving us the opportunity to sit down with various experts over the past couple of weeks here at the Center.  One theme kept coming up while I was listening to a couple of these individuals and it was a welcome distraction from the typical debt ceiling/government shutdown conversations…the secular bull market.

The chart below shows the long-term secular trends for the Dow Jones over the past 100 or so years.  You can see that the markets go through long periods of stagnation, in essence going nowhere fast; followed by periods of steady increases.  These periods of stedily rising markets (indicated below in green) are referred to as secular bull markets.  You can see that this year the Dow has finally broken out of the sideways trading range of the past 12 years. 

The U.S. equity markets have been in a positive trend for four years now, yet one expert stated this is the least trusted, least believed bull market he has ever witnessed.  Most investors erroneously believe that the environment has to feel good before it is the right time to invest.   Unfortunately, once it feels good to invest it is usually the wrong time, think buying technology stocks in 1999.

Whether or not we are in a secular bull market remains to be seen, but once we can say for certain that we are it is usually too late.  Having a financial plan and staying disciplined with your investments, I think, is the most important key to successfully meeting your goals.  

Angela Palacios, CFP®is the Portfolio Manager at Center for Financial Planning, Inc. Angela specializes in Investment and Macro economic research. She is a frequent contributor to Money Centered as well asinvestment updates at The Center.

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The information contained in this report does not purport to be a complete dexcription of the securities, markets, or developments referred to in this material.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  Expressions of opinion are as of this date and are subject to change without notice.  Past performance may not be indicative of future results.  Holding stocks for the long-term does not insure a profitable outcome.  Investing in stocks always involves risk, including the possibility of losing one’s entire investment.

Step Up in Basis Part 2

In Part 1, we covered a “step up in cost basis” principles with regards to real estate. In this post we will address step up in basis rules pertaining to marketable securities such as stocks, bonds, and mutual funds.

Your cost basis in a security is what you initially purchased it for plus any reinvested dividends.  So if mom bought 1,000 shares of Ford Motor Company back in 1980 when it was trading at $1.00 a share her cost basis is exactly $1,000 (trading costs such as commissions can also be included).   As of 10/25/2013 Ford was trading at $17.60 a share so if mom sold it today she would receive $17,600 from the sale of the Ford stock.  She would be able to subtract her basis for tax purposes ($1,000) and she would have a long term realized capital gain of $16,600.  At today’s long-term capital gains rates mom would owe Uncle Sam as much as 20% of that gain or $3,320.  However, let’s say mom never sold her Ford stock and left it to you after her death.  If mom died on October 25th 2013 your new inherited basis would be the closing market price of Ford on the date of death ($17.60).  Assuming you sold Ford stock at $17.60 you would owe nothing in capital gains thanks to the step up in basis rule.  Please remember that this analysis is only relevant if you are inheriting assets in a taxable account. If you are inheriting Ford stock inside of an IRA (or other similar tax deferred account) then the cost basis is irrelevant – at least for income tax purposes. 

What if mom is feeling generous and decides she wants to gift you the shares of Ford Stock while she is alive?  In this instance you would also receive mom’s cost basis of $1.00 rather than the higher step up in basis at death. 

As always, income tax consequences alone should not dictate financial decisions.  However, care should be taken to maximize both gifts and inheritances. Please speak with a financial advisor about cost basis and other tax-related issues.

Matthew Trujillo is a Registered Support Associate at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters.  You should discuss tax or legal matters with the appropriate professional.  The illustration is hypothetical.  Individual results will vary.  This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.  Individual results will vary.   This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.  Center for Financial Planning, Inc., Raymond James Financial Services, Inc., its affiliates, officers, directors or branch offices may in the course of business have a position in any securities mentioned in this report.

A Bond Market Doomsday – Part 2

 With the bond bear potentially rearing its’ ugly head, it is important to understand what a bond bear market looks like to properly prepare a portfolio for it. 

Only one in five investors know how interest rates affect bond prices

In a 2009 study on financial capability, only 21% of respondents knew that prices on existing bonds generally go down when interest rates go up (National Financial Capability Study, 2009 National Survey, Financial Industry Regulatory Authority).   Prices and rates typically move inversely because older bonds with lower rates are less attractive to buyers than newly issued bonds that offer higher rates.

If bond prices have been at all-time lows this stands to reason that bond prices have a long way to fall and indeed they began this fall earlier this year.

When rates go up, prices go down

Take a look at the examples below, illustrating the effect of rising rates on a 5‑year US Treasury bond.

Source: MFS

This is a hypothetical example that represents the effect a rise in the interest rate of a new issue bond may have on the price of existing bond issues.  Although bond prices and interest rates typically move inversely, a change in interest rates is only one factor determining the price of a bond security.

However, what bond bear markets lack in depth, they make up for in length.  In Part 1 I suggested we are in a time similar to the early 1950’s when rates bottomed out at similar levels to where we are today.  Below is a table of returns for the 10 years following rates bottoming taken from the Federal Reserve database in St. Louis. 

*Stock represented by the S&P 500, Treasury bill rate is a 3-month rate and the Treasury bond is the constant maturity 10-year bond, but the Treasury bond return includes coupon and price appreciation

Rising rates historically means rising income and total returns.  If rates rise slowly, interest has a chance to outweigh loss of principal over time as you can see in the chart above.  Devastating returns are not seen on the bond side of the ledger, but rather slow returns that tend not to keep up with long term inflation rates. 

Diversification rather than Doomsday

While we are not at doom’s doorstep, diversification is certainly the key, as it always is.  Most likely, not all areas of the bond market will suffer at all times over the coming years.  Investors must be careful of certain investments with characteristics similar to that of bonds (i.e. “bond proxies”) though.  Investing in something like dividend paying stocks in place of your bonds could add a lot of potential risk to the portfolio.  These types of positions will not support a portfolio in times of a stock market correction like bonds generally do.  It is important now more than ever to work with your financial planner to make sure you have a well-diversified portfolio and are making decisions with your overall financial goals in mind.

Angela Palacios, CFP®is the Portfolio Manager at Center for Financial Planning, Inc. Angela specializes in Investment and Macro economic research. She is a frequent contributor to Money Centered as well asinvestment updates at The Center.

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Diversification does not ensure a profit or guarantee against a loss.  The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  The information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily of RJFS or Raymond James.  Expressions of opinion are as of this date and are subject to change without notice.  This information is not intended as a solicitation or an offer to buy or sell any investment referred to herein.  Investments mentioned may not be suitable for all investors.  Investing involves risk and investors may incur a profit or a loss.  Dividends are not guaranteed and must be authorized by the company’s board of directors.  Past performance is not a guarantee of future results.

A Bond Market Doomsday – Part 1

 Eye-catching headlines like this are great ratings boosters right now.  Phrases like “Surviving financial annihilation” or “Devastating losses” have been en vogue lately because investors are becoming more aware that bonds may not be the pillar of our portfolios as we have come to rely on them over the past 30 years.  Yields on bonds have been kept artificially low due to the Federal Reserve’s intervention over the past several years with the Quantitative Easing (QE) programs.  However, now that it looks as though the FED will be backing off of their QE programs, since it looks like the economy will be able to stand on its own two legs, we are left with a bond market with yields at nearly all-time lows. 

Does this mean that the bond bear is finally out of hibernation? 

The chart below gives us a history lesson on the last time we headed into a bond bear market (early 1950’s).  Rates on the 10-Year U.S. Treasury bond were at similar levels to where they are today.

From what we have seen already this year, it does seem that rates have nowhere to go but up.  According to the above chart, it will be important to temper our return expectations coming from this bond portion of a portfolio.  The average return we have come to expect from bonds will likely be drastically reduced going forward.  If expectations are properly tempered, this need not “annihilate” our portfolios going forward.  In my next blog I will go into more detail of what a bond bear market has looked like in the past.

Angela Palacios, CFP®is the Portfolio Manager at Center for Financial Planning, Inc. Angela specializes in Investment and Macro economic research. She is a frequent contributor to Money Centered as well asinvestment updates at The Center.

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The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc., and not necessarily of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise.

Risk vs. Reward: Finding the Right Asset Balance for You

There are inherent risks in investing (you can’t control the market) but there are potential payoffs that help people tolerate that risk (like funding retirement). To better understand your own tolerance for risk, you need to first get the gist of asset allocation.  Asset allocation is a technique used to spread your investment dollars across different asset classes.  Stocks, bonds, and cash or cash alternatives, among others, are generally the most common components of an asset allocation strategy. 

Determining risk tolerance

Deciding on an appropriate allocation is an important exercise because it may be the most important investment decision you make due to the impact it can have on your overall return.  Your financial goals, time frame and personal resources all contribute to the equation. A risk profile questionnaire is a widely accepted method to help advisors and investors make asset allocation decisions.  

However, there are two significant limitations to relying solely on a risk questionnaire to make the asset allocation decision.  First, the way people think about risk is not stable and very often varies with market conditions.  Behavioral science research tells us that when the market goes up, the pain of past plunges typically fades as investors feel they can accept more risk.  The dynamic reverses when markets correct or go down.  Suddenly, the market elicits fear in the hearts of investors and tolerance for risk diminishes.

The second limitation with risk questionnaires is they don’t measure an individual’s need to take risk.  The purpose of an investment portfolio is to support the financial planning objectives or desired lifestyle. The plan will articulate the why as well as the how.  It helps answer questions like, “So, can I retire?” or, “Do I have enough to feel confident?”  The specific goals and time frames are the determinants of how much risk to take, even if there is a willingness to take on additional risk.

Committing to an asset allocation

Picking an asset allocation is important, but committing to it is even more important; especially in light of our changing attitudes about risk and reward.  Don't hesitate to get professional help if you need it. And be sure to periodically review your portfolio to ensure that your chosen mix of investments continues to serve your investment needs as your circumstances change over time.

Laurie Renchik, CFP®, MBA is a Lead Financial Planner at Center for Financial Planning, Inc. In addition to working with women who are in the midst of a transition (career change, receiving an inheritance, losing a life partner, divorce or remarriage), Laurie works with clients who are planning for retirement. Laurie was named to the 2013 Five Star Wealth Managers list in Detroit Hour magazine, is a member of the Leadership Oakland Alumni Association and in addition to her frequent contributions to Money Centered, she manages and is a frequent contributor to Center Connections at The Center.

Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment.  Prior to making an investment decision, please consult with your financial advisor about your individual situation.  Asset allocation does not ensure a profit or guarantee against a loss.

Three Skills to Help Women Become More Confident Investors

Many of my time-stressed female friends, colleagues and clients want to know how to create higher quality work/life balance. Launching meaningful careers, enjoying our families and creating financial confidence are outcomes we work hard to achieve.  At a time when women make up about half of the workforce, and control more than 50% of the wealth in the United States, research shows the financially savvy women have not achieved a level of investing confidence that goes hand in hand with greater wealth.

As a financial planner I work with women who are pioneers in their given career, possess personal confidence in creating wealth, and have strong savings values. However, these characteristics don’t necessarily translate from the office to their personal lives. But personal financial confidence is what gives you the opportunity to grow your savings and to build a solid foundation in retirement.

How to be a Confident Investor

Are you a confident investor?  If you are less than confident, it doesn’t mean you are stuck on that path.  Nothing could be further from the truth.  The reality is that your confidence can be strengthened with a few fundamental moves.

1. Create a financial plan.  This plan should not be viewed as a one-time event; rather a flexible and adaptive vision that you aspire to much like forging a career path that works for you throughout the different phases of your life.

2. Although it may seem counterintuitive, pay less attention to the markets and more to yourself and your financial goals.  Emotional reactions to things we can’t control often cause us the most trouble.  Refer back to your financial plan if your confidence in your investing ability begins to wane in light of current events.

3. Re-prioritize when necessary.   Changes can happen to take us off course in all aspects of life.  When change happens remember that cookie cutter advice doesn’t apply.  Look at your own life and evaluate what you need now and down the road.  Much like a mentor provides objectivity and perspective that can lead to good career decisions, share your current financial challenges with an advisor and address the worries proactively and with confidence.  

Why not leverage what you already have to create a financial plan and investing confidence that keeps you in the driver’s seat through all phases of your life?

Laurie Renchik, CFP®, MBA is a Senior Financial Planner at Center for Financial Planning, Inc. In addition to working with women who are in the midst of a transition (career change, receiving an inheritance, losing a life partner, divorce or remarriage), Laurie works with clients who are planning for retirement. Laurie was named to the 2013 Five Star Wealth Managers list in Detroit Hour magazine, is a member of the Leadership Oakland Alumni Association and in addition to her frequent contributions to Money Centered, she manages and is a frequent contributor to Center Connections at The Center.

Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  Investing involves risk and investors may incur a profit or a loss.  Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making an investment.  Please consult with your financial advisor about your individual situation.

Investing is a Marathon, Not a Foot Race

 I had lunch with a friend that turned 40 years old last week.  He mentioned that he runs in a few marathons. He used to run dashes.  A marathon is a lot different from a 100-yard dash.  Preparation is different, psychologically, mentally and physically you prepare differently.  

He changed his portfolio over the last few years because of the market volatility.  This new portfolio was geared towards mitigating risk in the next few months; kind of like a foot race but he is not considering the implications of the next 25.5 miles. Three things came to mind as I was looking at his new selections.  First, I had my research assistant run some analytics on the two portfolios and then compared the old and new. 

Old Portfolio:

• Centered on equities
• 10 year plus time frame
• Partially passive and partially active approach
• Focus on growth rather than risk, liquidity or safety

New Portfolio:

• 5 year or less time frame
• Focused on a possible need for current income
• Very risk adverse (actually underperforming the market by 2-3% annually)

After taking a look at his portfolio changes and the implications, I offered these three suggestions:

#1 Find a consultant that understands what you want to accomplish.

Sit down and let a planner you trust (that has a similar investment philosophy) really get to know who you are and what your family goals are. Talk about what you want your portfolio to accomplish.  Complete that firm’s financial planning questionnaire, risk tolerance questionnaire, etc.  Start out with someone who is a CFP or has a vast background in working with family planning situations and money.  Pick a person who wants to keep you on track over the next 20-30 years. 

#2 Develop an asset allocation that is right for you.

First you should clearly articulate your goals.  After that is done, get the right mix of asset classes in your portfolio.  Don’t worry so much about the actual investment selection – it has the least amount of validity in the entire process. Look for managers that have 10 years experience and an average or better track record.  If possible select investments that have a small asset base. They may be more nimble than large investments. 

#3 Meet annually with that planner.

And lastly, meet once a year (both you and your spouse) for an hour or two with that planner to discuss your goals, feelings, and perceptions of your planning. Reviewing your financial situation periodically is an important part of the financial planning process; it helps maintain forward momentum, establishes a checkpoint to assess progress, refocus efforts, and ultimately helps you cross the finish line you’ve set for yourself.

Matthew E. Chope, CFP ® is a Partner and Financial Planner at Center for Financial Planning, Inc. Matt has been quoted in various investment professional newspapers and magazines. He is active in the community and his profession and helps local corporations and nonprofits in the areas of strategic planning and money and business management decisions. In 2012 and 2013, Matt was named to the Five Star Wealth Managers list in Detroit Hour magazine.

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Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material.  Any information is not a complete summary or statement of all available data necessary for making an investment decision.  Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment.  Prior to making an investment decision, please consult with your financial advisor about your individual situation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily hose of RJFS or Raymond James. Asset Allocation does not ensure a profit or protect against a loss.  Investing involves risk and investors may incur a profit or a loss regardless of strategy selected.

House Hunting How-To: Deciding on the Best Down Payment

 You have decided to purchase a new home. Now questions start racing through your mind. How much do we put down?  What is our interest rate going to be?  Do we get a fixed loan or a variable loan? Do we finance it over 15 years or 30 years? In today’s historically low interest rate environment the answer to some of these questions may surprise you.

Let’s take a scenario between John Doe and John’s identical twin brother Jack Doe.  John and Jack have the same exact job, the same income, and the same assets.  Everything about them is the same except for how they approach money decisions.  John is a firm believer in staying out of debt. He doesn’t believe in financing anything. He pays cash for cars, houses, vacations etc…  Jack on the other hand believes that responsible use of debt could be a good way to get ahead in life.  He firmly believes that you shouldn’t put more then 20% down on a house, you should finance a car, especially when interest rates are less then 3%, he’ll even put a vacation on a credit card to earn the mileage points, making sure he pays it off within a month or two. 

John and Jack are looking to purchase an identical home in the same neighborhood; same square footage, same interior design, same lawn animals, same everything.  The purchase price of the house is $250,000. They both have identical investment portfolios valued at $250,000. John has the option to finance it with a 30-year fixed loan at 3.5%.  But instead John takes a look at his finances and decides he will take the money out of his investment portfolio and buy the house outright.  John now has no money left in his investment portfolio, but at least this will save him that pesky $1,200 mortgage payment over the next 30 years. He doesn’t like the fact that his investment portfolio now has a 0 balance, but he intends to rebuild his drained investment account by adding $1,200 each month. 

Jack, on the other hand, decides he is only going to put down 20% on the house and keep the rest of his money invested. He needs to come up with 20% of $250,000, or $50,000. After the down payment, Jack will have $200,000 remaining in his investment account.  He won’t be able to add any funds to his investment account because he needs that money to pay the mortgage.

Let’s break down the impact of their decisions after 10 years factoring at a 6% interest rate compounded annually for their investments. Let’s also assume the value of their homes has also appreciated in value at 6%:

Jack has less equity in his house because he put 20% down so, after 10 years, he still owes the bank $150,000 on the original $200,000 mortgage note. From the totals, it might appear that Jack made a slightly better money decision, but life is not quite that simple.  We can’t possibly account for all the “what if’s” that life might throw at the two brothers over that 10 year period. 

Here are some things to consider: 

• What if John had a sudden emergency such as an unexpected job loss over that 10-year period?  He has no liquidity to tap into to help him pay the bills because he spent it all on the house. 
• How much mortgage interest can John deduct off his income tax bill annually?  None because he doesn’t have a mortgage! 
• What if house prices in the neighborhood depreciate in value instead of appreciate?  Jack could potentially hand the keys back to the bank whereas John could be stuck with a rapidly depreciating asset.
• What if John isn’t as disciplined as he thought he was and starts spending the $1,200 a month instead of saving it?  Jack might not be as prone to this problem because there is a big consequence to him not paying the bank $1,200 a month which is that he loses the house.   

As you can see, having a mortgage might not be the worst thing in the world. Even though it bucks the traditional value of having a home paid off as quickly as possible, there can even be some advantages to using debt responsibly. Make sure you talk to your financial planner when deciding if you’ll follow Jack or John’s example.

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The example contained herein is hypothetical and for illustration purposes only.  It is not intended to reflect the actual performance of any particular investment.  Actual investor results will vary.  Investing involves risk and investors may incur a profit or a loss.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  You should discuss any financial or mortgage matters with the appropriate professional.