How much interest income can I expect on $12 million? Can I live well off that income? (from Quora)

Good question. I’m assuming that you’re asking this question because you are, for whatever reason, expecting to be the recipient of $12 million. This could be from an inheritance, the sales of a business, winning the lottery, or something else. Whatever the source of the funds, congratulations!

I’ll also assume that after taxes, you’ll be left with $12 million, however, that may not be the case. Consider that depending on the source of the income, the location in which you live, and other factors, you may have to pay a significant amount of tax on the amount of money you receive. Consultant a qualified accountant or tax professional for help with calculating your tax liability.

Now to the exciting part… how much income can you expect to earn off of $12 million in cash?

The answer largely depends on your risk tolerance. You used the word “interest,” but I’m assuming that you’re open to investment vehicles other than those that pay interest. Bonds typically pay a “coupon” (similar to interest) and some stocks/equities pay dividends.

Investment approaches vary wildly — and yours will likely be based upon your philosophy on money, risk tolerance, and your age and future plans. You could put all of your funds in a high-risk, high-reward stock and significantly increase your assets (or lose it all). I wouldn’t recommend that approach, though.

The polar opposite would be to put the money into bank accounts, money markets, and CDs — which typically pay anywhere from 0% annual interest to 1.75% in today’s market. Some would argue that this approach would not keep pace with inflation, and while that would lead to a whole separate discussion, they are in many ways, correct.

A reasonable strategy would be to combine approaches. Don’t expect to “beat the market,” but understand that the market has ups and downs.

Here are examples of return on a few different approaches.

  1. Put it all into municipal bonds (but be sure to diversify, and consult a professional for help with this since there are complexities — don’t invest too much in one municipality or bond issuer, and ensure that bonds are rated well or insured by a reputable insurance company). Typically these pay 2–3.5% and income is generally tax-free if you live in the US and in a state where there is no income tax or you purchase your own state’s bond.Assuming all $12 million is invested in municipal bonds, assuming a reasonable rate of 2.5% (you can do better or worse), expect $300,000 in tax-free income annually. Depending on your tax bracket, the tax-equivalent yield is probably $400,000 – $500,000 annually. This means that if you had a taxable investment, you’d have to make $400k – $500k to do as well as $300k tax-free.
  2. Put it all into S&P 500 stocks, or better yet, an S&P 500 ETF. According to this article, the S&P has averaged 10% ROI since 1928. This assumes that you have a long-term time horizon, because in any given year, you may gain or lose a significant amount of value. Over the long term, we expect the S&P to live up to its historical averages, but there is no telling what the future holds.Assuming all $12 million is invested in the S&P 500 with an average rate of return of 10%, expect $1,200,000 of annual return (not necessarily “income”). Depending on your tax bracket and how long you hold the stock you buy, your keep will a bit lower — probably in the ballpark of $960k, +/-, though it greatly depends on your tax bracket and overall tax strategy. I’m assuming a long-term buy and hold strategy, which has you paying long term capital gains on your income rather than ordinary income tax. Keep in mind, though, that you cannot expect to receive a “coupon” or monthly/quarterly/annual distribution of profit. If you invest in dividend stocks, you may receive a dividend, which you may or may not choose to re-invest. Beware that during the Great Recession of 2008–2009, the S&P 500 index fell 57% from October 2007 through March of 2009. There’s no guarantee that you will make money each year. This is a longer-term strategy and you should not rely on this for any regular level of income.
  3. Put it into Bitcoin and hope that the current value of $8,200 as of this writing increases by 15% per year or more. While this approach carries significant risk and I would not recommend it (at least not for your entire $12 million), I include it here as an example.Assuming all $12 million is invested into Bitcoin, you can expect $1,800,000 in annual return. Your income, once again, depends on whether you sell Bitcoin or otherwise use it’s value to purchase goods/services, or if you hold it as an investment. Your “keep” depends on the IRS’ tax treatment of bitcoin.

There are a myriad of other approaches you can take, ranging from lower-risk to higher-risk.

The proper strategy for most folks generally involves a combination of approaches to ensure that regardless of market conditions, you can rest assured that you will not lose a significant amount of value and that you’ll continue to see ongoing income.

Your strategy may involve holding a certain amount of cash in low-risk, low-interest bank accounts or money market accounts in case of a market crash or recession, so that you can take advantage of the buying opportunity.

Warren Buffet’s Rule #1 is “Never Lose Money.” His Rule #2 is “Never Forget Rule #1.” This is important — and there are portfolio strategies that can limit your losses. Diversification is very important in this respect as well.

Mansions and Ferraris, or Safety & Security — You Choose!

My take? In your shoes, I’d take a fairly conservative approach. Unless you have dreams of living in a mansion with a fleet of Ferraris and Lamborghinis (or you have an extremely large family or other unusual expenses), $12 million puts you easily into “set for life” territory — as in, you never need to work again — or you can focus on a career that you love, regardless of what it pays. With very little risk, you can easily earn $200,000 – $300,000 in income, after taxes. While I’m not recommending that you take the lowest-risk approach, I’d recommend being cautious. A higher-risk approach can have greater rewards, but unless your desired lifestyle demands greater rewards, you may be able to sleep better at night if you play it safe.

Is it a bad idea to invest your life savings into an individual stock you believe in?

Question from Quora: I don’t believe in investing in some boring stock not touching the money for years and making 6–7% a year if you are lucky. I want to pick one stock that I trust will do well and double or triple in value but has a high risk factor, is it really a bad idea if I use stop losses?

Yes, it is a bad idea. That being said, I suppose that it depends on how much money makes up your “life savings.” It also depends on how much this money means to you, and how long it would take you to recoup this money if you lost it.

No company is infallible. Even if you think a company is great and has no chance of failure, think again, and look at history.

In 2008–2009, corporate mega-powers and banks were bankrupted or acquired for pennies on the dollar. Companies like Lehman Brothers, Washington Mutual, General Motors, and Chrysler were not immune. What makes you think that your favorite company is immune? Sure, in hindsight, we can see why some of these companies were at risk. But hindsight is 20/20, and few if any saw the Great Recession approaching.

With government bailouts, some of these companies were ultimately restructured and are still around today in some capacity, but if you were using stop losses, you would automatically be giving up on the company after the stock value declines by a certain amount.

To me, this approach sounds more like gambling than investing.

 

Consider this: If hedge fund managers can be beaten by monkeys, what makes you think you’ll do a better job at picking the best stock?

While 6–7% returns may seem “boring,” Warren Buffet’s Rule #1 is: “Never Lose Money,” and his Rule #2 is: “Never Forget Rule #1.”

Consider the impact of losing your life savings and having to rebuild from scratch. I won’t go through the financial modeling exercise here, but even a 20% loss could have a very negative impact on the ultimate value of your savings — let alone losing it all — which is far from impossible when putting all of your eggs in one basket.

While, from a strictly financial standpoint, you are better off investing in multiple low-fee ETFs that represent different markets, countries, and economic sectors, if you feel compelled to invest in one company because you truly believe in that company, I wouldn’t rule it out completely — but I’d limit it to a small percentage of your life savings.

You may be limiting your gains, but in my mind, more importantly, you’d also be limiting potential losses.

Only you know your risk tolerance… but if investing in your favorite company provides you with some level of excitement, then go for it — just remember that the potential worst-case scenario is that you could lose your entire investment. Therefore, if you only invest 10% of your life savings into this one company, an unforeseen catastrophic event that puts this company out of business would only impact a small portion of your life savings.

Plan accordingly and do not put all of your eggs in one basket.

 

I inherited $400k. Is it better to pay off my $400k mortgage, or invest the money? (question from Quora).

Here’s the back-story — a Quora user asked this question, and stated the following:

I’m 30 years old and bought a house a year ago, valued at ~750k on Zillow, and I owe $400k (4.25% interest) on it.

I’ve always liked the idea of living mortgage free, but is it worth paying off the lower interest rate (4.25%) that also gives me a tax break (for itemized taxes) vs. putting the money into investment (6% + return)?

It feels riskier to invest the money even if it does give a higher return….what’s the smart move?

(I have no other car/student/credit card debt and do have an emergency fund of 1 year living expenses saved and work full-time.)

My answer:

Others here have given good answers — and strangely, despite their recommendations being opposite, I am a fan of the posts by Masa Kawa and M. Taylor. Both make good points.

It’s a tough decision, but there are pros and cons to each approach… and in my mind, the decision of which choice is “right” depends not solely on the numbers — but on your future goals, your mindset, and a few other factors.

Let’s get started!

Step 1: Take a Minute to Consider Each Question Below

  1. What is your outlook on your own financial future? You mention that you have a one year emergency fund and that you work full-time. That’s a great start! Still, do you think that there is a good chance that you’ll need to tap into the $400k in cash any time soon? How stable is your job, and if you lost it, what are your prospects for finding another job quickly?
  2. If you had $400k in cash, how likely are you to spend it poorly, or invest it poorly? In other words, is it “safer” being tied up in your house?
  3. Sanity check to help confirm the validity of your answers to the above two questions — what is your track record in terms of financial responsibility? You have a 1 year emergency fund and a full-time job — and again, that is a great start and indicates to me that you’ve been responsible, but only you can answer this question.
  4. What are your plans for the future? Some of the questions below may seem unrelated, but bear with me — you’ll see how they play into your decision:
    1. How long do you think you’ll live in this house?
    2. Do you ever plan to start your own business, or make a non-traditional investment?
    3. Do you envision your salary going up? Down? Or staying the same? Do you think you’ll remain in the same line of work, or that you may be seeking a change in a few years?
  5. Psychologically, does one approach just “feel” right? Some people hate making a mortgage payment, and even if it’s not the best financial move, they love knowing that their house is paid off… Think about what feels right — but before making a decision, read through the rest of this post and think through every aspect of the decision.

Step 2: Consider The Options

Investing
Comparing the potential return on investment of paying off your house vs. investing in something else, it’s admittedly a tough call. Sure, the S&P 500 has shown about 10% annual returns since 1928, which, adjusted for inflation, comes down to about 7%. That sounds great — but once you tack on tax liabilities, depending on your tax bracket and your trading strategy, you may lose another 20% or more on taxes, bringing you around 5.6% or less.

While no one can truly call the market, many believe that because we’ve been in a bull market for so long, we are due for a correction soon. It’s impossible to truly know when or if a correction will take place — however, history has shown us that there are no guarantees — and if you will need access to the $400k any time soon, it may not be smart to invest it all in the stock market. Had you done so just before the 2008–2009 crash, you may have lost up to 54% of your investment over the course of 17 months. It’s hard to get timing right.

You have a one year emergency fund — if you believe that you could get by without any salary for one year, and you don’t expect to lose your source of income any time soon, you may be okay with taking a longer-term approach. If you have a 7–10 year time horizon, your returns over time will likely exceed the cost of mortgage interest payments. To further reduce risk and overall volatility, consider consulting a financial advisor, using a “Robo-Advisor” like WealthFront or Betterment, or using a diversified portfolio strategy. Also, don’t invest in individual stocks — instead rely on low-fee index funds and ETFs.

There are too many investment options to list here — you could invest in real estate, municipal bonds, or even your own business idea. These investments have varying levels of risk and return. For now, I’m focusing on what I’ll call a standard/diversified investment strategy. This does not mean investing in your best friend’s latest and greatest business idea after his last 12 have failed.

Advantages to Investing (assuming a fairly “standard” and diversified investment approach):

  1. Likely to earn higher returns over time than you would simply by paying off your house.
  2. Potential to use dividends from investing to pay a portion of your monthly mortgage payment, assuming you choose not reinvest them. This reduces the amount of money that has to leave your bank account each month — and there’s an underlying asset (stock) that will hopefully continue to grow over time.
  3. More liquidity. Even if you invest the entire $400k into the market, if you need to pull some money out, most of the investments I’m talking about above will allow you to do so (sometimes at the expense of paying standard income tax vs. long term capital gains tax). While you could end up having to pull money out during a down market, meaning that you’ve now lost money, at least you can get to your money without asking the bank for a loan or to refinance your house (which is what you might need to do if you used the $400k to pay off your house). And if you’re really in a situation where you need the money badly, it’s probably going to be harder to get a loan from the bank at that point (i.e. your credit may have taken a dip, or you may not have a salary or regular income).

Disadvantages to Investing:

  1. Potentially more risk exposure — though your house could dip in value as well, so it’s hard to say whether or not you’re really subject to more risk.
  2. Could be difficult emotionally to handle occasional losses and dips in the market. If you’re the type of person who can “set it and forget it” (hopefully relying on an advisor or a robo-advisor), then you’ll probably be ok.
  3. You won’t have the peace of mind of knowing that your house is completely paid off — but your investment should hopefully bring you a different type of peace of mind, and more liquidity.

Paying off the House

By paying off the house, you avoid paying 4.25% in mortgage interest. Yay! But as M. Taylor pointed out, after tax savings (mortgage interest deduction), that is likely closer to 3.25%

Now that you’ve paid it off, your money is tied up in the house. The house is a good investment too, right? Not so fast — it may be a bad investment. Over 105 years, home prices rose by under 1% per year.

And here’s food for thought… your house is a great form of collateral to secure a loan. As a business owner who has had to take out small business loans, I can say that it is a bit more difficult to borrow money from a bank without something as straightforward as a house to use as collateral against the loan. Business loans usually incur a higher interest rate and it is difficult or impossible to get a 30 year fixed style loan for a small business.

If you ever plan on starting a business where you may need some extra capital to start the business or grow the business, you may be better off keeping this money and using some of it for that purpose. There’s still risk in using money for a new business endeavor, any way you cut it (as a small business owner, you’d be personally liable to pay it back), but why not take advantage of the beneficial terms that you’ll get on a mortgage loan vs. a small business loan?

On the plus side, when you pay off a house, it’s a “done deal” and you know you can live there without monthly mortgage payments. It may not be the best investment, but it’s a tangible asset and it’s nice to live in the house and not feel like you owe anyone money. On the other hand, keep in mind that many billionaires and other wealthy individuals have in some way used leverage to get there — that is, they have used the money of others (such as a bank) to get there. $400k invested within a brokerage account has a much larger potential upside (and arguably higher risk, depending on how you handle the money) than paying off your mortgage. Even $400k left in cash, if used creatively when the time comes, could yield higher returns than you’d probably see by paying off your house. For example — in the event of a major stock market crash or other correction, you could decide to invest in the stock market then if you’re not comfortable doing so now. Or you could use that money to help you to start your own business when you are ready.

Advantages to paying off the mortgage:

  1. Peace of mind — the knowledge that you don’t owe the bank anything.
  2. As long as you maintain homeowner’s insurance, the knowledge that your money is now invested in an asset that is truly “not going anywhere.” It may decline to some extent in value, but the majority of your principal is safe. It’s worth noting that even if the value of your house declines, you’d still have to pay back the mortgage (unless you want the bank to foreclose on your house). So, investment gains or losses on the house are not impacted by the fact that you hold a mortgage (other than the mortgage interest paid).
  3. If you don’t have the best track record with spending money or making investments, paying off the house will tie up this money and prevent you from spending it or investing it foolishly.

Disadvantages to paying off the mortgage:

  1. You lose flexibility to invest in something that might have higher yields.
  2. That cash is no longer liquid, or easy to access.
  3. You’re no longer leveraging one of the easiest ways for a homeowner to borrow money — which, when you think about it, can be used for whatever you want to use it for. You have $400k and could pay off your loan. By not doing it, you are leveraging your house to get a very low-cost loan, presumably with a 30-year payback. Good luck getting a business loan like that.
  4. Here’s one that most people don’t think of — but you’ll no longer have the bank on your side. Right now, they are working to protect their asset/collateral. This means that they’ll make sure that you have the proper type of homeowner’s insurance policy in place, that your taxes are paid. This may not be extremely valuable, but it’s kind of nice to have someone else keeping an eye on things.

Finalizing Your Decision

Here are some decision-making criteria that would apply to the general public:

Pay Off The House If…

  1. First and foremost — you have an emergency fund that will last you at least one year and cover all regular expenses, and then some.
  2. It is something that you feel you need to do psychologically to free yourself from the burden of the mortgage — as long as you realize that you could probably see greater returns and have more liquidity by putting your money elsewhere.
  3. You have a poor track record with investments and/or spending habits, and you’d rather know that you can’t touch the money.
  4. You don’t have aspirations over the next few years to start a business, take a work sabbatical, or make other investments.

Don’t Pay Off The House If…

  1. You don’t have an emergency fund that will last you at least a year — in which case, consider taking a portion of the money and investing in something very low in risk (CDs or high-interest checking accounts are safest, but also currently offer almost non-existent returns — consider municipal bonds as well).
  2. You may want to take a break from work for a while, switch jobs, start a business, or basically “step into the unknown” in any way in the near future. Some extra cash or other liquid assets will be immensely useful to you.
  3. You want to see the best return on your investment over a medium-long time horizon. Note that it is true that more returns usually mean more risk, however, history has shown us that over a long period of time, it’s extremely likely that you’ll do better by putting your money into other investments.

Keep In Mind A Few “Hybrid” Choices

  1. Consider paying off some principal on your mortgage, which will effectively reduce the interest that you pay over time. You could take $200,000 and pay off some of your principal to put you in a better place.
  2. If it’s the monthly mortgage payment that you don’t like, work with a financial advisor to craft a strategy to use dividend-paying stocks or other investments with ongoing coupons or dividends to put toward you monthly mortgage payment. Or do it yourself by investing in Dividend ETFs (note that I do recommend doing thorough research or working with a professional).
  3. Realize that you’re not limited to any one strategy. You could pay down $100k of your principal, put an extra $25k into your emergency fund, and put the rest into equities (stock and stock-like) investments (or some combination of bonds and equities).

Knowing Your Situation…

To recap your situation, it sounds as though you are in a pretty good place financially. You’ve managed to save enough to last you a year — and not everyone is capable of doing this!

Knowing your situation, I would advise against paying off the mortgage. If you have a long-term time horizon, you’ll see better returns elsewhere, and, perhaps more importantly, you’ll have a lot more flexibility. That said, you know yourself better than I do — the caveat that I would add here is that if you do not pay off your house, be very careful with the money and think long and hard about your goals before you decide what to do with it.

If there is a nagging feeling that you should pay off the house, look at where that is coming from. If you truly don’t trust yourself with the money, that’s one thing (and paying off the house may be best). If you think that it’s the best place to put your money, take some time to challenge that assumption.

 

What are best things to invest in (question asked of me on Quora)?

 

There is only one “thing” that you can invest in that has the potential to reliably yield returns that are significantly higher than individual stocks (or the entire market), real estate, bonds, and all of the other “popular” investments.

This is one of the best kept-secrets in the world of investment, and I’m about to let you in on this secret. Warning: Once you’ve learned what I’m about to share with you, there is no “un-learning” it. What you do with the information is up to you.

The World’s Greatest Investment is… You.

Some may read the above statement and think “wow, that’s cheesy” or “…such a cop out answer — I wanted to hear about flipping houses, recommended stocks, currency arbitrage, hedge strategies, and more,” hear me out — I’m going to explain how investing in yourself can effectively be the best investment you can make — not only in a “touch-feely” kind of way, but also in terms of cold, hard cash.

Investing in yourself will not only yield greater financial returns than investing elsewhere, but will also result in significant personal growth. You’ll build skills, confidence, and passion, which will serve you well for the rest of your life.

Let me explain.

The question “What are the best things to invest in?” can be tough to answer without getting some additional details. The “best” investment choice for you depends on your goals, your age, time horizon, and your financial situation. But there’s one investment that is never a mistake.

If you’re anything like me, you’ve often gotten the feeling that you’re not tapping into your true potential — like there is so much more out there for you, but that certain things are getting your way. These things generally relate to a feeling of “lack” — you feel as though something is missing. Some of the common things that we feel that we lack are:

  • Time
  • Energy
  • Money
  • Knowledge or Ability
  • Passion/Motivation
  • Security/Peace of Mind
  • Love

And when we come from this place of lack, we often limit our true potential because we don’t even know what is possible for us; we don’t know what we’re capable of.

If you’re caught up in the trap of self-doubt, lack, or you just feel as though you haven’t tapped into your true potential, I recommend reading some books. A good place to start would be:

To become all that you can be, it’s important to get in touch with the thoughts, feelings, and “reasons” that are holding you back from your full potential. I could probably write a book on the topic of mindset, however, I’ll simply state that mindset is often the main thing that holds people back from achieving all that they are capable of.

Once you feel as though you’re in the right mindset, it’s time to master the steps of self-investment success!

Four Steps to Self-Investment Success

  1. Learn
    1. Choose topics that interest you. Don’t pressure yourself or shoot your ideas down just because you don’t see how you’d ever make money by learning about “X” — whatever “X” may be. Maybe you want to learn about African Dance, but can’t see how you’d ever make money from that — but don’t worry about this right now. In the worst case, the subject that you learn about may end up being “fuel” for connecting with people in new ways — which may ultimately lead you to new opportunities.
    2. Find books, workshops, and local events focusing on the subject. You can search Amazon for books, do a Google search on the subject, or check out Meetup.com to find local people who share the same interest. You can also check out Coursera to search for online courses.
    3. Read these books, attend these events, and take these courses.
  2. Do
    1. Just to clarify, “doing” may not mean jumping in wholeheartedly. While some may recommend “ripping off the band-aid” or jumping into something fully, you may not be ready for that, and that’s ok. We’re talking about smarting small. Baby steps will help you to determine whether or not you’re on the right path.
    2. With certain subjects, “doing” automatically goes along with learning. You can’t truly learn to play the piano without having a piano in front of you. With other subjects, though, you’ll need to put yourself out there. You may “academically” learn to write by reading books on how to write books, or studying Strunk and White’s “The Elements of Style.” Unless you put yourself out there by attempting to write, you may not know if you truly enjoy this activity, and you certainly won’t be able to gauge your level of ability or improve… which leads me to point “b” below:
    3. Get feedback. Recognize that when you get started with something new, you may not be an expert. All outside perspectives have the potential to benefit you as long as you keep an open mind. Some people may not be supportive and may be critical of what you do because of their own issues or fears — be careful not to let them crush your spirit. At the same time, listen for potentially valid feedback on how you might approach your craft better. This applies to everything, from writing — to sports — to running a business.
    4. Going along with point “b” above, find ways to get consistent feedback, and to be held accountable. In business, consider joining a group such as Vistage — something that will enable you to get honest feedback from peers (who have shared many of your experiences). Or go to networking events and work on forming your own peer group.
  3. Reflect
    1. Are you enjoying what you do? Do you feel that you are building momentum? Note that not every moment may be enjoyable — even if we have certain “natural talents,” things don’t always come easily. As Angela Duckworth said in her TED Talk, the largest predictor of success is “grit” — the ability to push yourself and power through tough situations — so don’t give up too easily.
    2. Do you feel as though the new skills that you’re learning or experimenting with are a good use of your potential? Do you feel like you’re “in the zone” when learning, growing, and practicing this activity? Or do you feel that your time would simply be spent better elsewhere?
    3. Many people stay in the same job for years (or perhaps for life) because they are simply afraid of the unknown. They have a gnawing feeling that they are capable of so much more — but it is easier, safer, and “financially responsible” to stay where they are. Does the skill that you’re learning and practicing help you to feel more alive than you’ve felt in a while? Through this skill, do you feel as though you can be your best self? If you are stuck in a job that you don’t like, does dreaming about leaving this job to work on “X” excite you?
  4. Decide to Make a Change
    1. Here’s where you take action. The earlier steps are baby steps to help you to get your feet wet. Here’s where you basically make a choice. No choice is 100% permanent, but by committing to something and declaring it, you will remove a lot of the doubt in your mind.
    2. This does not mean that you have to immediately quit your job, sell your house, and move to Tahiti to open that surf shop! Smaller decisions are ok too — maybe instead you commit to an intermediate step, like meeting and interviewing ten surf shop owners within the next six months — and saving the money to allow you to travel and do this. The important part is that you remain in motion. Don’t let fear stop you — continue moving toward a goal.

The above process is not a “one and done.” It’s actually an ongoing cycle. For instance, I happen to be experimenting with writing as we speak. While I’ve done a fair bit of writing in the past, I’ve had thoughts and dreams of writing a book. I’ve started smaller by beginning to blog part-time, and posting on Quora.

You may also be at step #1 when it comes to one of your hobbies/interests/professional goals, and step #3 on another. For example, I’m probably at step #2 when it comes to writing — but I’ve already completed step #4 when it comes to starting and running a business. It’s ok for you to explore multiple ideas at once — as long as you recognize that you only have 24 hours in a given day; dividing your focus too much is a recipe for failure.

Here’s The Best Part

Yesterday, I answered a similar question similar to this one on Quora, and then also posted the answer to the On.Cash blog, where a reader commented. The reader, Fille De Finance, pointed out that there are so many free resources, and that investing in one’s self does not necessarily mean spending a lot of money.

I feel lucky and blessed to be living in a time when information is literally at our fingertips. If you’re reading this post, you likely have access to a computer or a smartphone — which means that there is so much information available to you — and not all of it costs money.

I have found numerous books for $0.00 at eBookDaily. These are Kindle books, and even if you don’t have an Amazon Kindle device, you can read these on your smartphone or computer using the Kindle app.

There are literally hundreds of millions of blogs, many of which contain very useful information. If you get creative, there are so many ways to find free information.

More than that, you can use the Internet to connect with people who have common interests and to reach out to people who may be able to help you to learn, grow, and explore.

Risk & Return on Investment (ROI)

So let’s not forget that when investing, there is the expectation of return. When it comes to the stock market, there’s no telling what it will do. If you had invested in certain stocks in October 2007, when the Dow Jones Industrial Average had exceeded 14,000 points, you would have been mighty upset in March 2009, when it reached a trough of about 6,600. There’s always risk in any investment.

What’s the risk when you invest in yourself? Well, there’s risk that you won’t be very good at what you’re trying to achieve — or that you won’t like it — or that it won’t yield any positive financial results. Ultimately, there’s the risk that you’ll spend time, and perhaps some money, and that it won’t get you anywhere financially. One of the main risks is to your pride. Keep in mind, though, that growth cannot happen without failure.

So what’s the upside? It’s significant.

  1. You’ll learn about yourself; what you enjoy and what you do not enjoy.
  2. You’ll be able to “cross something off your list.” If you don’t explore the dreams and ideas that “light you up,” you’ll be left wondering. You’ll use your energy thinking about what “could have been” because you never fully explored the possibility.
  3. You’ll get better a things. Maybe your idea won’t work out or won’t make you any money — but it’ll give you a new, unique perspective that you can share with others, and a good way to make conversation at a party if nothing else.
  4. You may just do very well, financially — or you may achieve enough success for this to serve as your starting point.

With regard to #4, there’s a significant chance that you will be successful. If you’re smart about it, there’s very little downside in investing in yourself, but a ton of potential upside.

This is a concept that experienced investors often call “Asymmetric Risk and Reward.” The amount that you are risking, if you were to lose it all, is much less than the amount of the potential return or upside.

I’ll give you an example of what investing in myself did for me, personally. Sharing personal details is a bit out of my comfort zone… but here goes.

When I was in high school, I dabbled with starting a business that would provide web hosting and data center services. This was really before the days of the Internet, but I was intrigued by all of the potential that I saw in the Internet.

Here are some examples of how I followed the four step process outlined above:

  1. Learn: I read what I could about web hosting and the Internet. In the early 1990’s, information was more scarce, but I read books, dialed into online bulletin board systems (one might consider these an early version of the Internet), and talked to people who knew more than I did.
  2. Do: I pitched car dealerships and realtors on my ideas to images and descriptions of car and real estate inventory online. I guess they didn’t take the 16 year old kid seriously or think that this “Internet thing” would really take off. Bummer. I continued to “do,” though — I learned about web programming (both HTML/design and web-database integration) and found a couple of clients for whom I built sites, and hosted them. I also launched a free redirection service that provided customers a faster, shorter URL for their long web addresses. This is back when domain names still cost about $75/year. I learned a lot about programming and running a small business.
  3. Reflect: I continued to run this side business throughout college, periodically reflecting on where I was and where I could be. I came up with new ideas and plans for the future. I realized that I enjoyed what I was doing — and that I was pretty good at it.
  4. Decide: After college, I worked at a startup company and did some consulting. After the startup went out of business, as many did in 2000–2001. I made the decision that I was going to get my own business going, full-time. I started small, but I did make the conscious decision to devote nearly 6 months to writing code to expand my free redirection service into a hosting business. This ultimately led me to build a business that grew to multiple millions of dollars in revenue annually and over 30 employees.

Now, don’t get me wrong — it may sound “simple,” but it certainly wasn’t easy. After spending about 6 months of developing software and living off of savings, my business launch was far from an instant success.

In the first week, my total sales were about $10 — not exactly the pot of gold that I had imagined at the end of the rainbow. But I pushed myself to learn more about what I was doing wrong and what I was doing right. Eventually, $10 weeks turned into $10 days ($70 week). And with more patience, hard work, and hope, a few months later I had my first $1,000 day! This money was not all profit; I had expenses in running my business.

And even after hitting $1,000/day, I had the naive idea that I had “hit it big” and that I was now “set for life,” only to discover that as much as I tried to automate this business, there were things that I just couldn’t automate. It was a lot of hard work, and I was initially on-call 24/7, 365 days per year. Eventually, I hired people and got help. While running a business was certainly not easy and did not always feel like I was “living the dream,” the experience that I gained was immensely valuable to me, and will benefit me for the rest of my life.

I ran the business for many, many years, and only recently, I merged my business with another business.

I invested in myself — not only financially, but in terms of time and effort to learn as much as I could about a particular subject. I spent a lot of time reading and speaking to resources who knew more than I did. I spent time learning, coding, and experimenting. As I built up my confidence, I decide to spend some money — investing in hardware, software, and staff resources to build my business.

While I look back, I realize that without investing in myself, none of this would have happened.

So what was my true ROI?

I can’t say that the below example is 100% accurate, but it should give you a rough idea.

  1. Years 1–4 were spent primarily learning and experimenting — running the business as side business. I probably spent a few hundred dollars per year in books and other resources. Total investment, $2,000 at the most.
  2. Years 5–7: I experimented more seriously and probably spent about $5,000 on hardware. I earned a few thousand dollars each year, paying back the $7,000 spent to date, with a few thousand dollars to spare (my total business earnings might have been around $10,000).
    1. A “side” benefit here was that although I had my Bachelor’s Degree in Computer Science, it was largely the learning that I did on my own that enabled me to land a very well-paying career as Chief Software Architect for a startup company out of school — earning well into six figures when I would never have been able to do so with my schooling alone — BINGO — instant ROI.
      1. If we simplify this example and assume that $7,000 was invested and that five years later, I made back $10,000 through my own business, and landed a career that earned me at least $50,000 annually more than I would have made otherwise, we are talking about an ROI of over 50% annually over the course of those 5 years. Ok, so yes, I also spent a lot of my time on learning growing… but when you look at the pure financial impact, it’s undeniable that my self-investment made a huge difference. I actually held that job for almost two years, further increasing my returns.
  3. Year 8: I began to work on my own business full-time, and invested about $30,000 into new hardware after seeing some success. I believe that my “profit” was about $50,000 that year. It was grueling — I worked 24/7, and while I loved a lot of what I did not, I didn’t love all aspects of running a business.
  4. Years 9 and beyond: While I won’t expand on every detail, I will say that most years, I was often able to pay myself as much as I would have probably earned at a “job,” if not more. I continued to learn a lot, and built a valuable asset that is still serving me today, both financially and in terms of my own personal growth (helping me to build knowledge and skill, and to create additional opportunities).

Moving forward, what was better was that once I got the business going, I was often able to reinvest profits while still paying myself a reasonable salary — and grow the business even more. Sure, there were tough years when I couldn’t pay myself much at all — but there were also great years.

Before I felt like the business had solid momentum, I made financial investments that felt very speculative. While I had some confidence that I would succeed, I wasn’t quite sure if I would. I spent money that I had earned in other ways (i.e. not produced by the business). This was a bit scary, and a bit exciting. If I do rough math, I’d say that annual returns are easily well over 50% per year.

Where else can you get a 50% annual return on investment?

What is more is that this investment in myself has already had an impact on me personally that I will take with me for the rest of my life.

Seasons change and markets go up and down, but investing in yourself is the only surefire way to yield lifelong benefits.

The Perfect Investment for the “Average” Person

On Quora, someone asked how the average person should invest his or her money.  One of my followers requested that I answer this question.  Below is my answer.

When reading this question, a number of follow-up questions come to mind, such as:

  1. How old is this person?
  2. What are this person’s goals?
  3. Does this person have a family or other people depending on them?
  4. What is the person’s income?
  5. What sorts of assets does this person own? What is the person’s net worth?

There are so many potential definitions of “average.” According to this Wikipedia article, the US Census Bureau reported a mean personal income of $44,510 based on the 2015 Current Population Survey.

To some, that income may seem very low, to others it may seem high, and to others it may seem “average.” My point here is that everyone has different perspectives on what is truly average.

That said, I’d like to give a real answer to this question. Of course, this is based upon my own thoughts.

According to USA Today, the “average” American has $3,600 in credit card debt.

Most credit cards charge interest rates of 15% or more on balances.

Since you’d be hard-pressed to find an investment that steadily and reliably pays more than 15% in the long-term, the unexciting answer is that it would be best for the average American to start by paying off credit card debt.

Next, look at other debts. Without going into too much detail, my rough rule of thumb would be that any debt upon which you pay 7% or more in interest should probably be paid off before seeking other investments. This is just my opinion; there may be some valid reasons to make investments before paying off this debt.

Moving on…

Assuming that there is no high-interest debt standing in the way, one assumption that I’ll make is that the “average” American is not a finance expert.

Taking it one step further, even “finance experts” are not always finance experts. In a world where hedge fund managers are consistently outdone by monkeys, can an “average” person really expect to be an expert investment picker?

My answer is no.

While no answer is the “right” answer and everyone has individual needs (disclaimer: talk to you CPA/financial advisor/yada yada before making any decisions), my recommendation would be to try to remove any thought, active management effort, and emotion from your decisions. It is easy to get emotional about your money, and history shows us that some of the best times to invest is when fear is the greatest.

I’d recommend one of these options:

  1. If you’re in it for the long term, and you don’t need your money for 7–10 years or longer, consider investing in a simple, low-fee S&P 500 ETF (exchange traded fund). This is basically a fund that represents the entire S&P 500 index — without having to invest in individual stocks. The S&P 500 has shown to return roughly 10% (not accounting for inflation) over the long-term, according to Investopedia. An example option would be the SPDR S&P 500 ETF Trust, stock symbol SPY.
    1. Note: It’s never a bad idea to diversify and only invest a portion of your assets into a single index, sector, or country. Therefore, you may want to put some of your money into foreign stocks, emerging markets, commodities, real estate, bonds, and other investments.
    2. For the reasons mentioned in the note above, if you’re investing a significant amount of money (whatever the word “significant” might mean to you), see option #2 below.
  2. Use an online “Robo-Advisor,” such as Betterment or Wealthfront. These are designed for the “average” person because there have very low investment minimums. Compared to a traditional investment advisor, fees are very low (well under one half of one percent). Tools like this can help you to diversify. They automate investment decisions to take the emotion out of it. Once again, I’d still recommend ensuring that you’re in it for the long-term. This means 7–10+ years without needing your money. If you have short-term liquidity needs, you may end up needing to pull your money out at a loss if the market is down.
  3. This one is my favorite option. Consider investing in yourself so you can be more than “average.” Some ideas are as follows:
    1. Purchase self-improvement and personal development books.
    2. Attend personal development and business-related courses and workshops.
    3. Use the funds to start a business that you’ve always dreamed of starting — or at least invest in learning more about how you might approach starting this business.

Let me comment a bit more on #3 because I believe it deserves more attention.

One of the greatest ways to build wealth is to start your own business. If you are smart, passionate, and you work hard, you will likely be able to earn more than you would have earned in the stock market or in other investment options. When you start a business, there is essentially unlimited upside potential. It is difficult to say the same about other traditional investments.

To sum it up, you are better than “average” — so believe in yourself.

The “Not So Dreamy” American Dream – The Dark Side of Home Ownership

Jim, a close friend of mine, has mentioned to me more than once that he feels a bit behind-the-curve.  He’s 35 and has never owned a home or any sort of real estate.  He’s a manager for a large telecommunications company and is paid well.  That said, he just recently paid off some credit card debt that he racked up in the past.

Jim lives in the Washington, DC area now, and is considering relocating within the next couple of years.  Ultimately, he’d like to end up in Florida, and so he mentioned that he’s had some thoughts about buying a place in Florida and potentially renting it out (for rental income) prior to moving to Florida.

Silhouette of Man Standing Against Black And Red Background

Now, I’ll stop here — based on the title of this post, you might assume that it’s all doom-and-gloom discussion from here — that I’m going
to tell you why it’s a bad idea to buy a house.  Well, full disclosure — I own a home and an investment property.  So, obviously, I don’t think home ownership is a terrible idea.

Here’s the thing — there seems to be an assumption, at least in the United States, that there is something wrong with you if you don’t own a home and that home ownership is automatically the right move.  

Maybe I was reading into things when we spoke, but Jim and I are good friends and speak openly about our thoughts and feelings — and I got the vibe that Jim felt somewhat bad about himself.  After all — many of Jim’s peers are homeowners.  So Jim feels like he isn’t quite where he “should” be in life.

So, I shared my thoughts with Jim — I simply stated that buying a home is not always the “right” move, in my opinion.  His response was “Yeah, but at least I’d be building equity.”  True.  Sort of.

The Equity Myth

Sure — it’s true that buying and owning a home allows you to build equity.  In fact, to some extent, it can be considered “forced savings.”  Effectively, when you have a mortgage, saving money becomes automatic.  If you don’t want to destroy your credit and have the bank to take ownership of your house, you will make the required monthly mortgage payments.  Without this level of pressure, some people may not naturally find the motivation to put money away each month to save.  For those who like spending and find it difficult to save, I agree — being forced to save is a good thing.

“Yay, now I get to build equity!”

Not so fast.  But seriously — not so fast.  Sure, you will build equity by paying down a mortgage, but be aware that this is a very slow process.  Standard 30 year fixed mortgages are designed so that the payment amount stays the same each month throughout the life of the loan.  This means that early on, your payment amount is made up mostly of interest.

For example, let’s assume that you bought a house for $375,000 and put down 20% ($75,000).  So, you take out a $300,000 mortgage.  On this loan, at 5% interest, you pay $14,899 the first year in interest.  Why? The average balance on the loan is roughly $297,630 during the first year.  You’re paying 5% on this balance.

Have a look at the table below:

Date Interest Principal Balance
Jan, 2017 $1,250 $360 $299,640
Feb, 2017 $1,248 $362 $299,278
Mar, 2017 $1,247 $363 $298,914
Apr, 2017 $1,245 $365 $298,549
May, 2017 $1,244 $367 $298,183
Jun, 2017 $1,242 $368 $297,815
Jul, 2017 $1,241 $370 $297,445
Aug, 2017 $1,239 $371 $297,074
Sep, 2017 $1,238 $373 $296,701
Oct, 2017 $1,236 $374 $296,327
Nov, 2017 $1,235 $376 $295,951
Dec, 2017 $1,233 $377 $295,574
2017 Total $14,899 $4,426 $295,574

Principal paid off the first year is only $4,426.  While that’s significant, you spent $19,325.52 but only truly increased your equity by $4,426.  That means that you “spent” $14,899 — just like you would have on rent… well almost.

As you’re probably aware, in most cases, tax rules allow you to deduct the cost of interest on your primary residence from your income.  While this does not mean that this interest is “free,” it does reduce the cost to you — provided that you have an income to offset the expense.  For tax purposes, you can reduce your income by your mortgage interest expense. While this example is oversimplified, if your average overall tax rate is 25%, you would save 25%.  This means that on the $14,899 you spent, you’d save about $3,725 — meaning that you actually spent $11,174.25.

When I bought my first home at a young age, I don’t know if I had fully thought this through.  Call me naive, but for some reason, I think my natural assumption or gut feeling was that by owning a home, I was no longer “throwing my money away” as I would have on rent — but that all of the money spent on my mortgage was effectively building equity.

In the example above, it’s like you’re actually spending $11,174.25 in the first year you own the house.  Now, that may be ok with you.  After all, you would have spent that much per month on rent — or maybe more.  At least you get a place to live — and you will eventually begin to build more equity as you pay down your mortgage.

Take a look at the table below showing how much interest you’ll be paying for the first 10 years.

 

Year Cumulative Interest Cumulative Principal Balance Cumulative Payments Yearly
Principal
Yearly Interest
$300,000
1 14,899.48 4,426.10 295,573.90 19,325.58 4,426.10 14,899.48
2 29,572.52 9,078.64 290,921.36 38,651.16 4,652.54 14,673.03
3 44,007.52 13,969.22 286,030.78 57,976.74 4,890.58 14,435.00
4 58,192.31 19,110.00 280,890.00 77,302.31 5,140.79 14,184.79
5 72,114.09 24,513.80 275,486.20 96,627.89 5,403.80 13,921.78
6 85,759.40 30,194.07 269,805.93 115,953.47 5,680.27 13,645.31
7 99,114.09 36,164.95 263,835.05 135,279.05 5,970.88 13,354.70
8 112,163.31 42,441.32 257,558.68 154,604.63 6,276.36 13,049.21
9 124,891.41 49,038.79 250,961.21 173,930.21 6,597.47 12,728.10
10 137,281.98 55,973.81 244,026.19 193,255.78 6,935.01 12,390.56

Ok… now see a version of the table below with a “Tax-Adjusted Interest” column (representing the amount paid of interest paid after factoring in the assumed 25% tax discount) and a “Cumulative True Cost” column — which is the cumulative amount of money spent on interest after tax savings.

Year Interest Tax-Adjusted Interest Cumulative True Cost
1 14,899.48 11,174.61 11,174.61
2 14,673.03 11,004.77 22,179.38
3 14,435.00 10,826.25 33,005.63
4 14,184.79 10,638.59 43,644.23
5 13,921.78 10,441.34 54,085.56
6 13,645.31 10,233.98 64,319.54
7 13,354.70 10,016.03 74,335.57
8 13,049.21 9,786.91 84,122.48
9 12,728.10 9,546.08 93,668.55
10 12,390.56 9,292.92 102,961.47

Note that the above table is only talking about money spent on interest.  The true cost is reduced by tax savings, assuming that you have an income and that your effective average tax rate is 25% (in our example above).  But there is still an actual cost.  The $102,961.47 is actually money spent — that you won’t get back.

In addition to spending this money, you have also “spent” almost $56,000 in Principal, however, this is where your equity comes in — this isn’t money that truly was “spent” — this is your money.  This is the money that you effectively put into “savings.”  You paid down the cost of the house, and you’ll get that money back some day.  More on that subject later.

So, looking at the true cost of the mortgage, after year 5, you’ve spent about $54,000.  That averages out to $10,800/year, roughly — or $900/month.  In most cases, it’s safe to assume that a $375,000 house is going to do better for you than an apartment that you would rent for $900/month.

But wait… there are more costs.

Before I get there, let’s look at the difference between the words “cost” and “investment.”  For something to be an “investment,” there is an expectation of positive or profitable returns.  “Cost,” however, is simply an expense — something that you need to spend money on that will yield no return.

When discussing the purchase of a home, it makes sense to view the down payment and the portion of your monthly mortgage payment going toward principle as an “investment.”  The rest is really just an expense.  This is because the value of the asset — the house — is what is going to rise.  When you spend money on interest, upkeep, or taxes, those don’t truly yield a return.  You can consider these other costs to be “carrying costs,” of sorts — and they should be factored into the big picture.

Here are some costs we haven’t looked at yet:

  1. Real estate taxes
  2. Homeowner’s Insurance
  3. Closing costs when you buy
  4. Transaction costs of selling the house when you sell
  5. Home repairs and maintenance
  6. Opportunity costs
  7. Other “soft costs”

Real Estate Taxes

According to this article on Wallet Hub, the mean property tax rate across all US states in 2017 was roughly 1% (I scrolled to the middle of the chart ranking each state).  This means that property taxes on a $375,000 home will cost you roughly $3,750/year.

Now, this varies widely by state.  In Hawaii, it’s as little as about $1,000/year (0.027%), and in New Jersey, it’s almost $9,000/year (2.35%).  Keep in mind that many towns/municipalities/counties will also assess, a tax, which can, in some cases, effectively double the tax rate that you pay.

To keep it simple, we’ll stick to the $3,750/year in costs here.

Homeowner’s Insurance

According to Zillow, you can expect to pay about $35/month for every $100,000 in home value.  On a $375,000 house, that’s $131.25/month, or $1,575/year.

While it’s true that as a renter, you’d want to purchase renter’s insurance, as this article states, the average cost is only $12/month or $144/year.  The main reason for this is that renter’s insurance does not generally cover the property value or the building value; just your possessions (and in some cases, liability).

Closing Costs

According to Zillow, closing costs average between 2 and 5% of the purchase price.  At 3.5% (right in the middle of Zillow’s range), we’re at $13,125 in fees on a $375,000 home.

Sales Transaction Costs

As mentioned in the above, the buyer clearly pays certain closing costs when purchasing a new home.  But when you buy a home, a portion of your fee goes to the seller’s real estate agent, and a portion goes to your real estate agent. Traditionally, it has been 3% to each agent, for a total of 6%.  Some discounted options, such as Redfin now exist, however it is safe to say that each time a home is sold, about 4.5% in commissions will go to realtors.

Now, as we all know, the seller actually pays this fee.  What is not often discussed is that in some cases, sellers — especially those who haven’t stayed very long at the property, often feel the need to pad their asking price in order to cover realtor fees.  So, in a sense, I would argue that realtor commissions do impact the buyer… but since it’s difficult to calculate the true impact of this on the buyer, let’s ignore the realtor fees on the purchase of the home.

Inevitably, some day, you will sell your home.  Barring a major change in how homes are bought and sold, you can probably expect to spend 4.5% in commissions.  Assuming no change in the value of the home, on a $375,000 home, that puts your realtor commissions at $16,875.

Home Repairs and Maintenance

HGTV recommends setting aside 1-3% of your home’s purchase price for maintenance and repairs.  While the article talks more about fixing problems with your house, there are also other property maintenance costs, such as maintaining your yard, mowing the lawn, raking leaves, etc..

Lawn Mower, Hand Lawn Mower, Lawn Mowing

Now, you may enjoy yard work.  So, let’s leave that out of the equation.  And let’s assume that you’re also a “do-it-yourself-er.”  Let’s assume that between all of this, you only spend 1% of your home’s cost on maintenance.  That’s $3,750/year.

We won’t get into these details here, but before assuming that you’ll do all of your own housework, repairs, and outdoor/yard maintenance, you should think about whether or not you truly enjoy that kind of work, whether you have the skills and knowledge to do that work, and whether or not your lifestyle affords you the time to do this work yourself.

Opportunity Costs

Most people don’t think about it much, but there is also an opportunity cost associated with buying a house.  Let’s put aside the other “soft cost” items, such as lack of flexibility or the fact that once you purchase a house, moving becomes more difficult and more costly.  After all, there’s no way to truly quantify the cost of those items.  While the opportunity costs associated with buying a house may be thought of as “soft costs” to some, in that they don’t represent a tangible payment that you need to make each month, they are, in fact, a cost.  An opportunity cost is basically the loss of the potential gain that you could have seen by putting your money elsewhere.

This comes as a surprise to many, and even came as a surprise to me when I first read about it, but multiple studies and data analyses demonstrate that historically,  real estate is a bad investment.

In his article for Moneywatch, linked above, Larry Swedroe writes:

Yale professor Robert Shiller, in his book “Irrational Exuberance,” argued that home buyers may also be influenced by comparing simple returns on infrequent real estate transactions. Assume that a home in 2005 sold for 10 times the price it sold for in 1945. While that produces a simple return of 900 percent, the real (inflation-adjusted) annualized return was less than 1 percent.

The article mentions an assumption of approximately 1% in annual maintenance costs (a reasonable assumption, in my opinion), moves the needle and brings the “investment” into negative returns.

In today’s current market, it is relatively easy to find municipal bonds that pay 3% — typically tax-free if you purchase a muni bond from your state, or if you live in a state that does not charge income tax, you can purchase muni bonds from any state.  At a 25% average tax rate, this truly yields closer to 4% as compared to a standard investment taxable at ordinary income tax rate.

If you had taken your $75,000 down payment and put it into one or more municipal bonds pay 3%, you’d bring in $2,250 tax-free each year.  Assuming we paid cash for the closing costs ($13,125), that’s $88,125 we could have invested, earning $2,643 per year, tax-free.

While investing in the stock market could even yield double this, even after taxes, it can be significantly more volatile — and not everyone has the stomach for that type of investment.

Other “Soft” Costs

Here are a few things to consider.  I won’t go into an incredible amount of detail here, but homeownership has some drawbacks.  Mostly, the below items are just “food for thought.”  They may represent an actual “hard” cost at some point, but at the very least, they may result in less flexibility and/or a large investment of your own time.

  1. While you’re not “stuck,” once you buy, you’ve made a commitment to a home, and along with that home, the town and state that it is located within.  Can you move, sure?  But keep in mind that with transaction costs and fees, if you only live in a home for a few short years, you’re likely spending significantly more than you would have by renting a comparable place.  Would your decisions on where to live and work be influenced by the fact that you might lose a significant amount of money on your home if you move too quickly after buying the home?
  2. Going along with #1, what if the real estate market crashed shortly after buying your home?  This could leave you with a home that is worth significantly less than what you paid.  Depending on your mortgage amount, you may not be able to afford to move.  This can happen when a home is “underwater” — the amount borrowed to buy the home is more than the home’s value today.
  3. Landlords generally cover any sort of property repair.  Homeowners bear this entire expense.  There’s no way to know what will break, and you can protect yourself to some extent with a home warranty, but you’ll likely still spend money each year.  Some of these costs can be significant, and can come all at once — such as the cost of replacing a roof — the average homeowner spends about $6,600 to replace a roof, but depending on various factors, you may end up spending a lot more.
  4. Everyone pays for utilities, such as electric, natural gas, cable, etc., but in many cases, homeowners will pay more for these since homes are generally larger than apartments or townhouses (which are more frequently rental properties).  Whether you’ll spend more in utilities depends on the type of home that you buy — but it’s something to think about.

The True Financial Picture

One of the main points that I’ve been trying to deliver is that certainly, not all money “spent” on a house is an investment.  Much of the money “spent” is truly just an expense — money that you’ll never get back.  Sure, as you pay down your mortgage, you will increase your equity, and thus, the principle portion of your monthly payment is not an expense.  But other things, like closing costs, interest payments (even after considering the tax benefit), real estate taxes, homeowners insurance, opportunity cost, and upkeep of the house are what I’d consider “true” expenses.

The table below lists most of those expenses.  For now, we’ll leave out costs that may be considered “soft costs,” including opportunity costs.  After all, you don’t have to write a check (in most cases) to cover these soft costs.

Disclaimer: As with many of the examples, for the sake of simplicity, the table below is somewhat oversimplified.  It does not reflect changes in real estate tax costs due to changes in the value of your property over time.  There are several other factors that we don’t account for, however, I feel that it gets pretty close to representing the bulk of the expense of homeownership.

Year Expense Cost Total Money Spent
1 Closing Costs $13,125 $13,125
1 Mortgage “Expense” $11,147 $24,272
1 Real Estate Taxes $3,750 $28,022
1 Homeowners Insurance $1,575 $29,597
1 Maintenance Costs $3,750 $33,347
Year 1 Total $33,347
2 Mortgage “Expense” $11,005 $44,352
2 Real Estate Taxes $3,750 $48,102
2 Homeowners Insurance $1,575 $49,677
2 Maintenance Costs $3,750 $53,427
Year 2 Total $20,080  
3 Mortgage “Expense” $10,826 $64,253
3 Real Estate Taxes $3,750 $68,003
3 Homeowners Insurance $1,575 $69,578
3 Maintenance Costs $3,750 $73,328
Year 3 Total $19,901  
4 Mortgage “Expense” $10,639 $83,967
4 Real Estate Taxes $3,750 $87,717
4 Homeowners Insurance $1,575 $89,292
4 Maintenance Costs $3,750 $93,042
Year 4 Total $19,714  
5 Mortgage “Expense” $10,441 $103,483
5 Real Estate Taxes $3,750 $107,233
5 Homeowners Insurance $1,575 $108,808
5 Maintenance Costs $3,750 $112,558
Year 5 Total $19,516  
Cumulative Total Money “Spent”   $112,558

What happens if you go to sell the house?  Well, it really depends on what the market has done, but we’ll talk about that now.  In any case, after 5 years, you’ve spent almost $113,000.

If you sell the house after only 5 years of owning it, assuming a 1% annual increase per year, compounded, your $375,000 home is now worth $394,129.  Congratulations!

But let’s see how the numbers play out.

  1. You list the house with a broker at $394,129, and because the market has gone up by 1% per year, you get your asking price.
  2. You find a discount broker to sell your house, and pay a total of 4.5% in commissions — $17,736.
  3. $394,129 – $17,736 = $376,393.
  4. Congratulations, you just “made” $1,393 — the gap between the $376,393 that you got to keep after selling the house and your purchase price of $375,000.

So, not factoring in all of the potential soft costs, you yielded $1,393 in returns.  That’s a total return of a whopping 0.37% — which, annualized, comes out to a return of less than 0.074% (factoring in compound interest).

But wait… factoring in your true costs over the 5 years, listed in the table above, we’d add $112,558 to your costs.

So, let’s take the $376,393 and subtract this amount — yielding $263,835.

Congrats!  Your “investment” yielded you negative $111,165! That’s a return of -29.64%.

White and Tan English Bulldog Lying on Black Rug

 

 

Ok, so let’s be fair here.  You did live in the house… you got something out of it… and you would have spent money on rent if you did not purchase this house.

What if you would have rented?

I just went on a very quick, and very unscientific fact-finding mission to figure out what the “rental equivalent” of a $375,000 house was.  So, for example, if, on average, a house that sells for $375k in a given area has 4 bedrooms and 2 bathrooms, I wanted to see what I could rent an equivalent house for. I found a house in South Plainfield, NJ listed at $370,000 that had 4 bedrooms and 2 baths.   This house looked a bit older and, in fact, was built in 1969, but appeared to be in decent shape.    A quick, cursory look at other houses in the area yielded similar results in terms of square footage, as well as the number of bedrooms and bathrooms.

A more updated single family home in the area, also with 4 beds and 2 baths, is listed for rent for $2,150/month.

  1. $2,150 per month, annually = $25,800 per year.
  2.  $25,800, escalated at 3% per year, which is somewhat average in the rental market looks like this:
    1. First year: $25,800
    2. Second year: $26,574
    3. Third Year:  $27,321
    4. Fourth Year: $28,192
    5. Fifth Year: $29,038

Over the course of 5 years, you’d spend a total of $136,925.

But wait, that’s still higher than the $111,165 that I would have spent on the home.

Not so fast.  Let’s assume you took the $75k down payment and $13,125 in closing costs and invested that money in 3% municipal bonds as mentioned earlier.  This would yield you $2,643/year, tax-free.   Over 5 years, that’s $13,215 earned.  This brings the cost of renting down to $123,710, factoring in the income that you would have had by putting your down payment into a better, but still relatively safe, investment.

The gap between renting and owning a home is now just $12,545, or just over $2,500/year.  So, you did marginally better by owning a home over the course of 5 years than you would have done by renting…  not factoring in those other “soft costs” that I mentioned.

The picture would be very different if you had only lived in this house for one year — and only at about five years does it start looking like the decisions was even possibly a smart financial move.  Without stepping through all of the math here, let me show you the impact of moving after years 1-5.

  • Year 1: You lose $23,484 over renting.
  • Year 2: You lose $16,015 over renting.
  • Year 3: You lose $7,585 over renting.
  • Year 4: You gain $1,940 over renting.
  • Year 5: You gain $12,545 over renting.
  • Year 6: You gain $24,211 over renting.
  • Year 7: You gain $37,140 over renting.
  • Year 8: You gain $51,205 over renting.
  • Year 9: You gain $66,502 over renting.
  • Year 10: You gain $83,072 over renting.

Best and Worst Case Scenarios

The examples that I’ve given in this post are based upon average rates of return, average tax rates, average maintenance costs, etc..  If anything, in order to ensure that this post did not appear biased, I think that I underestimated the cost of homeownership.

That said, reality could be much better or worse than my projections.  You may have to replace the entire roof of your new house for $15,000 during the first year.  You could be buying the house at the height of the housing bubble (like early 2006), not knowing that in some areas, home values will drop by about 50% in the next few years.

Maybe you’re purchasing at an opportune time — when values have hit their near-term bottom and  will continue to rise steadily for years to come.

You never really know.  But one thing that you do know is that nothing is a completely “safe bet.”

ball, casino, chance

So What is the Would-Be Home Buyer Left to Do?

My main purpose in writing this blog post is to share some of the potential pitfalls and caveats of homeownership.  I feel as though in our society, there’s a strong bias toward homeownership.  My goal is to convey the fact that while owning a home has its benefits, it is not the panacea that many assume it to be.

Owning a home presents significant risks.  These risks are exacerbated if you’re not sure of how long you’ll truly live in the home that you purchase.  When buying a house, there are also many costs that most people don’t think about — and then there are unexpected costs that can arise as well.

It is true that over the long-term, owning a home will likely be a better financial investment than renting.  But are you sure when you buy a house that you will be in that house for 5+ years?

Younger folks who haven’t truly established roots in an area tend to be more transient — and often, even when they think that they will stay in a certain area, plans change.  Things come up.  You get a job offer in another city.  You decide that you’re looking for a change.  You get a divorce.  Sometimes even when you think you know what the future holds, you don’t.

There’s no getting around the fact that one can never be 100% certain.  My recommendation is to ensure that you’ve considered all factors before you make the decision to buy.

If you can check the below boxes, I think that buying may be a smart move for you.

  1. You plan to stay in the house (and obviously the area) for a minimum of 5 years.  Some “sub-factors” to consider are the following:
    1. Is your job stable?  Do you like your job?  Are there plenty of other opportunities in your area if you lost your job, or left your job?
    2. What’s the chance that you’ll get tired of the weather, the traffic, or the pace of life where you live?
    3. Are you married, in a relationship, or single?  Is it a possible that a new relationship could take you to a new city?
    4. If you are married, are you and your spouse on the same page?  Are you both committed to the area?  Is your relationship solid?
    5. Do you have children or plan to have children?  If you plan to have a family, does the home you’re purchasing meet the needs of this growing family?  Good school district?  Enough room for everyone to spread out?
    6. Does the home you’re considering meet your lifestyle needs?  Might you need things like a home office?  A play room for the kids?  An exercise room?  A kitchen with room to cook elaborate dinners?  Consider your needs, and talk them through with your spouse and/or your family.  Make sure you’re getting into a home that meets your needs.
  2. You have enough money saved to put down at least 15-20% of the home’s cost. Certain home buyers may qualify for a much smaller down payment — or even no down payment.  But doing so can lead to serious financial stress (remember that new roof that I referenced earlier?).  While outside the scope of the article, I’ll say that there are many drawbacks to buying a home if you don’t have enough savings to cover a significant down payment.
  3. You have income to cover the mortgage.  NerdWallet.com recommends that  36% or less of your monthly income should cover your mortgage and monthly debt payments.  Said another way, look at your monthly income after taxes.  If you won’t have roughly 2/3 of this payment left after covering your mortgage and other debts (such as student loan repayments), think very carefully before you commit to buying a home.
  4. At a minimum, you have an additional 3-5% of the home’s cost saved up in a savings account,  low-risk (and liquid) investment account, or other emergency fund.   To feel even safer, I’d recommend 5-10%.  Things come up.  While you could get potentially get a home equity line, there’s value in knowing that you have some cash put away.  This becomes even more important if you choose to put less money down on the home that you purchase.  If you lose your job, can you continue to make mortgage payments until you find a new one?  Can you afford to be out of work for 3-6 months?
  5. You have thought a lot about owning a home — the pros and the cons, and you really feel that it is for you.  You recognize that there will be frustrations — things will break and you’ll have to either spend the time to repair them yourself or hire someone to do so.  You realize that the market may take a bit of a dip, and that if you move or sell the house in a few years, you’re ok with that.  You know that there is risk, but you believe that the benefits outweigh the disadvantages.

As a departure from my usual cautious approach, I’ll add something here.  Some people may realize that owning a home may not be the best financial investment, but may want to purchase a home anyway.  Why?  Well, it affords you certain intangibles, such as the ability to feel more “at home” when you’re at home.  You can customize your home however you like — decorate, paint, and even renovate to your heart’s content.

If owning a home is something that you know you want to do because it will add to your quality of life, ignore #1 in the list above.  While it’s still a good idea to know that you plan on staying in the area (and in the home that you purchase) for a while, it may be ok for you to “throw caution to the wind” and buy a home.  Here’s the thing, though — at that point, it’s very important to be able to solidly check boxes 2-5 above.  In fact, if you’re buying a home knowing full well that you may end up moving before the five-year mark, I’ll boil it down to a simpler rule:

Before buying the house, have at least 25% of the home’s value available to you in liquid assets (such as cash in a savings account or a low-risk investment account).  Ensure that 36% of your monthly income will cover your mortgage payment and other monthly debts.

You may choose to take that money and use it to put 10%, 20%, or even all 25% down when you purchase the home — but ensuring that you have immediate equity in your house (or a large emergency fund) will offer you some protection if you sell your house soon after buying.

I’ll detail my reasons for this recommendation in a future blog post.

If you have 25% of the home’s value available to you in liquid assets (that you either plan to keep liquid or put toward a down payment), and if 36% of your monthly income will cover all monthly debt payments, then even if buying a house is not a financially smart move, you may simply want to do it anyway — because living in a house is the lifestyle that you’re looking for.  And that’s ok — you can probably afford it.

If you are first-time homebuyer, though, and you are “light” on liquid assets, buying a house before you are truly ready can open a financial can of worms.  Before proceeding with buying a house, stop to think about your overall goals as well as your ability to handle unexpected expenses or life events that may arise.

Red Stop Sign

Edit: A Quora user pointed out the fact that most people may not fully benefit from writing off the interest expense on their taxes since in order to do that, you need to give up the standard deduction. In 2017, the standard deduction is $6,350 for an individual and $12,700 for a married couple, filing jointly. Therefore, you may not receive any tax savings. This further increases the cost of home ownership and creates even more of a case for renting.

A blog post “On” On.Cash

Welcome to On.Cash.  I’m Russ.  This is my first blog post*.  Well, sort of.  Let me explain.

Who am I?

GN5C5670

Hi.  I’m Russ.  I am a technology enthusiast.  So much of an enthusiast, in fact, that I started a technology company at a young age.  I ran this company for about 20 years, and in 2016, I decided to merge my company with another company in the industry.  I continued to work for this company as the Chief Information Officer for about a year, at which point, I decided to step back a bit more and work for the company as a contractor while pursuing other interests and passions.  I have maintained my position as a shareholder and board member, despite no longer being a full-time employee.

For many reasons, I felt as though the time had come to merge my business with a larger business, which would effectively change my role within the company.  One of my primary reasons for making this decision to do this was to enable me to take some time to explore other hobbies and interests.

Owning and operating a business is a more-than-full-time job.  Shortly before the merger, my company had approximately 30 employees and hundreds of customers. Customers and employees mean responsibility — and I felt a personal sense of responsibility to each employee (and their families) and each customer.

Don’t get me wrong — I had a team that I trusted; and without this team, the company would not have succeeded.  But as the owner — the one who makes all of the decisions — you tend to carry a lot of weight on your shoulders.

As a major shareholder of the company, I still want to do everything in my power to help the company to grow and do its best.  Since the merger, however, I’ve also had more help at the top.  Having others capable of handling the business at a higher level has enabled me to “step back” and explore some of my other passions — this blog being one of them.

What is On.Cash?

Friends and family members have often considered me to be a trusted resource when questions of a financial nature arise.  Why?  I have no clue!  I have no formal training in finance, though it is a subject that has always interested me.

In terms of my credentials, I suppose I do have some.

  1. I built my own business and ran it for over 20 years, bringing revenues from $0 into the multi-million dollar range, managing and overseeing all aspects of the business.
  2. I’ve evaluated and taken out multiple business loans.
  3. I’ve purchased 3 homes and an investment property.  I’ve done quite a bit of research into different mortgage options and I’ve refinanced twice.
  4. I have experience investing in multiple different types of investments.
  5. Majoring in Computer Science in college, I did my fair share of math — though I’m still far from a mathematician.

While none of the above make me a true “expert,” I feel as though I have learned quite a bit along the way.

Some of the things that I’ve learned or realized throughout my journey in the world of personal and business finance have really surprised me — and seem somewhat counterintuitive.

Initially, I had some thoughts about developing an app to simplify certain financial decisions for people.  After thinking about it, though, I felt like an informational blog would be the perfect companion for an app.  In fact, I felt that a blog would provide me with a venue to document and clarify my thoughts on each topic and get some third-party feedback prior to developing such an app.

My Promise (and my disclaimer)

Financial decisions can have a huge impact on our lives.  In this blog, I will offer my thoughts on various topics (mostly finance-related, but other areas as well).  In some cases, users like you may comment and voice their own thoughts publically.

I cannot promise that my ideas or other ideas shared on this site will always be right for everyone.  Nor can I promise that I am “the authority” on every single subject that is discussed on this site.  What I can promise is that I’ve either had some experience or done enough research that I feel comfortable sharing my thoughts.

Because I value personal growth and learning, I am very open to feedback.  If anything on this site is inaccurate or if you simply have a different viewpoint, please contact me or comment on the blog post.

My quick disclaimer: Please consult your accountant or financial advisor before making any important financial decision.  You, and solely you, are responsible for any decisions that you make. Neither this blog nor I will be held responsible for the success or failure of your financial decisions.  Enough said.

Having said all of that, my goal is to help people to better understand areas that are often cloaked and obscured by complex industry jargon and nuances — and help those same people to make decisions that take into account the data that is truly meaningful, rather than going with what is assumed to be the “right” answer based on the popular societal viewpoint.

* Oh, and to wrap up my thought from the first paragraph in this post — this actually isn’t my first blog post ever — I did write an occasional blog post for my technology business, though normally that task was left to others.  I enjoy writing — and look forward to sharing much more with you in this blog.

Here’s wishing you good reading, good luck, and good finances!