Real Life Financial Planning

Hand of the businessman with the house

This past weekend my family has made the move into a new home, which needless to say, has been a chaotic process.  It really got me thinking, though, about real estate/home ownership and how it fits into client portfolios and their financial plans.

The mantra of the middle class is buy a home.  But is it always the best decision for your money?

Buying residential real estate certainly poses some undeniable advantages.  For many people, there is a certain pride in homeownership.  After all, it is the epitome of the American Dream.  Additionally, the interest and property tax portion of your mortgage is tax-deductible, and not unimportantly, homes tend to increase in value, build equity and provide a nest egg for the future.

But what is very often overlooked by the average American is the opportunity cost of their money and how their mortgages play a role in that.  A recent Wall Street Journal article highlights the important decision individuals face when they have excess cash.  It recommends taking a close look at what interest rates you pay on a mortgage and how those compare to the savings amount on your bank account as well as the rate of return on investments in equity and bonds.

When homeowners do this, they often are struck with a revelation: they are likely not getting as high of a return on their investment as they would have if they were invested more heavily in equity.  Ultimately, the opportunity cost of having your money tied up in your mortgage could actually hurt your long-term wealth.  Even worse, the tax breaks you are receiving do not cover the amount of loss incurred from your interest rate!  A recent Bloomberg article went so far to say that this simple understanding is one of the distinctions that separates the world’s wealthiest individuals from the middle class and one of the major contributing factors to income inequality.  Basically, it argues that a major difference between the middle class and the top 1% is that the middle class have too much of their portfolios tied in up residential real estate that is not providing adequate returns.

There is a theory out there that wealthy individuals are simply more skilled investors.  A recent study explains that this is not true. (In fact, they might be worse!)  Wealthy people just tend to own most of the equity in the economy, meaning that when business does well, they reap disproportionately large benefits.  Generally speaking, rich individuals own the upside of the economy in the form of stock, while the middle class’s gains are limited by the slow growth of housing wealth.  It is no surprise that the collapse of the housing bubble has exacerbated wealth inequality because stocks recovered more strongly than real estate did.  Maybe the difference between you and the 1% is just your perception of the options available to you.

Surely, shelter is one of the basic necessities of life.  Everyone has to live somewhere – but taking the time to consider all of your options before making any large financial decisions is something that every person should do.  At the very least, you should consider the opportunity costs of your cash and look into advantages of a less expensive housing option, renting, or investing more in equity to ensure that you are getting the most out of your money in the long run.

At Sherman Wealth Management, we believe that real life decisions call for real life financial planning.

These are the kinds of decisions we want to help you make, so don’t hesitate to contact us today to get started.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

 

Do Interest Rates Have You Worried About Buying a First Home?

Guide to Buying Your First Home

Did the recent interest rate hike news cause any delay to your plans to house hunt? Are you wondering – given the rate increase and current market turmoil – if this is really the right time to purchase a first home, or if renting makes more sense for you right now?

Actually, the exact opposite happened. Rates actually fell from 2.3% to 1.55% on the US 10-year treasuries (a common indicator of how mortgage rates are priced), their lowest point since September 2012. If you already own a home with an ARM or 30-year fixed mortgage, this is also a good time to refinance or reduce debt at these low rates.

Remember a house or condo is both a home and an asset that can appreciate over time. No matter what they’re saying on the news, what’s important is what makes sense for your finances, based on your goals and what’s happening in your local housing market.

Here are a few things to consider:

Evaluate your current circumstances:

  • What would your mortgage payment be in relation to current rent? A good rent-versus-buy calculator can be found at Realtor.com
  • Do you plan to be in the area for 5 years or more? The housing market will fluctuate. If you need to sell quickly, you may have to sell for less than desired, whereas a booming market can provide quick sales for a profit.
  • Can you afford the additional costs? The cost of home ownership is more than just the mortgage payment. There are taxes, insurance and sometimes homeowner’s dues that need to be considered, not to mention upkeep, repairs, upgrades, and furniture!

Assess Your Finances:

  • Have a good understanding of what your assets and liabilities are.
  • Consider what you can afford. Being house poor and unable to save for emergencies, retirement, college or other financial goals can create a stressful situation.
  • Speak with a lender about which programs you may qualify for; what a lender will approve you for and how much you can afford may not be the same thing.
  • Take a look at your credit report. AnnualCreditReport.com offers a free credit report from all three credit bureaus. Get one from each bureau and check it for accuracy.
  • Meet with a financial advisor to strategize your financial planning Is it better to make a higher down payment, pay down debt to get your debt to income ratios lower? Or is it better to leave the money invested so the lender includes this in your financial reserves?

Get Pre-approval:

  • Your chosen lender will review your financial information and credit, then make an assessment about how much home you can buy, what down payment is required, and the best loan program. The lender then provides a preapproval letter.
  • A second option is having an underwriter review your completed file, evaluating your income, credit, and financial assets, then providing a pre-approval letter.   Having an underwriter review your file may require application fees and other costs to be paid up front.

Contact a real estate agent:

Start your search online to help narrow down location and potential neighborhoods. This can save time (and therefore money) by giving you a sense of where you want to live and what is available in your price range.

  • Pay attention above all to location: be sure you are within an acceptable commute to work, schools and other activities that you will be involved in on a regular basis.
  • Consider resale value: do not buy the most expensive home in the neighborhood.
  • Consider how you want to use your financial resources: fixer-uppers are the best bargains but take both cash and time to complete.

Buying a home is an exciting decision and can result in a solid investment that appreciates over time. Whether or not this is the right moment to purchase is something you should evaluate carefully with your financial advisor, based on your current financial plan and your long-term goals, not based on the news or economic “predictions.”

While interest rates may have risen slightly they are still at historic lows, so don’t miss out the opportunities that a low-interest rate environment offers homeowners and prospective homeowners.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Donald Trump and the Benefit of Financial Foresight

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Donald Trump’s current net worth – as he would be the first to tell you – is estimated to be between $2 and $4 billion, most of which he made through inheritance and real estate investments, along with other business dealings. An article in National Journal recently took a look at what might have happened if he had invested in an S&P 500 index fund back in 1982 when his inherited real estate fortune was estimated to be worth “only” $200 million.  According to National Journal’s calculations, if he’d invested carefully in index funds, Trump’s net worth would be a whopping $8 billion today.

Does this mean Donald Trump is a bad investor? Not necessarily: the oldest lesson on Wall Street is that everything is easy in hindsight.

While highly speculative, those numbers do highlight the ongoing debate over which is a better investment – real estate instruments or stocks. Both stocks have and the real estate market have had great runs in recent history and, depending on when you invested, you could make cases for both investments being the better choice.

But the stock market and the real estate market both experience volatility, dips, and extended recovery times so, for the average investor, a portfolio composed of mainly real estate or other fixed assets (like art or collectibles, for instance) poses some risks that should be hedged with proper cash flow planning, a diversified portfolio, and proper tax planning.

Cash Flow Planning

A good financial plan takes into account how much cash you need access to, or may need access to in the future. Cash flow planning should be a key factor in deciding whether real estate investments are part your individualized financial strategy.

As National Journal points out, Trump claims he is willing to spend upwards of $1 billion of his own money to fund his presidential campaign, yet his financial disclosure statements show that he may have less than $200 million in cash, stocks, and bonds. The rest of his fortune is tied up in real estate investments, which could be much harder to liquidate and use for his campaign.

Most of us aren’t running for president but, if something like the 2007 housing collapse were to happen again, any investor who is predominantly invested in real estate could have problems liquidating those – diminished – assets for retirement, college funding, or other non-presidential goals.

A solution: diversification.

Diversification

Whether you are investing in real estate or the stock market, diversification is always a prudent way to address your own risk tolerance and use proper foresight in creating a winning strategy.

While with real estate funds, diversification can be achieved via many factors, including residential vs commercial investments, differing location focuses, and differing interest rates and financing mechanisms, it is still fundamentally one sector, subject to sentiment and swings.

With the stock market, on the other hand, diversification allows you the opportunity to invest not only in different asset classes, such as stocks, bonds, and money market funds, but in a variety of sectors and industries as well. Over the past 60 years, historically, the stock market has averaged an 8% annual return, so investors with strategically balanced and diversified portfolios, there is the opportunity for steady, while not spectacular gains, with the potential for less risk than investing only in the real estate market.

An investor who is properly diversified through multiple asset classes – including real estate if it makes sense for their own customized strategy – is potentially better protected against the short term results of one asset class experiencing a crash or a prolonged dip.

Taxes

Another thing to consider is that options for investing in real estate in IRAs and other tax-deferred accounts are complicated and not every custodian will allow you to include real estate investments in a tax-deferred account.

Hindsight vs Foresight

While Donald Trump is an outlier because his high net worth shelters him from some of the issues with primarily being invested in real estate, it’s intriguing to consider “what if.”

In the case of a more typical investor, a little foresight can go a long way in making sure you are on your way to achieving your own financial goals. A sound financial plan should be tailored to individual goals and cash flow needs, with a customized cash flow plan, and diversified across multiple asset classes for the potential for steady and compounded growth over time.

Whether you are a Donald Trump with a large inheritance or a young professional just getting started, a solid plan and strategy puts the benefit of hindsight where it belongs: in a conversation over coffee or cocktails, and not as the basis for a winning investment strategy.