Financial Tip of the Month Archives

April 2012

Is home equity an investment?

When determining the mix of stocks and bonds in your financial portfolio, should you include the equity in your home? It's an important question. If you add the value of your home (minus the outstanding mortgage) to your portfolio, you may find that the mix of stocks and bonds needs to be adjusted.

A general rule that some follow states that the stock portion of your portfolio (including stock mutual funds) should equal 100 minus your age. Using this rule, a fifty-year-old man should invest 50% of his portfolio in stocks and the rest in bonds or other generally conservative investments. Real estate fits into this "other" category. Say you have a financial portfolio that's worth $500,000, evenly allocated between stock and bond mutual funds. Let's further hypothesize that you have $100,000 in home equity. Adding that equity to your financial portfolio will change the mix of stocks and other investments from 50/50 ($250,000 in stocks; $250,000 in bonds) to 42/58 ($250,000 in stocks; $350,000 in bonds/other). Because your portfolio is now less heavily weighted toward stocks, you may decide to increase the stock portion. That will mean, other things being equal, accepting greater volatility and risk.

How does home equity compare with more traditional investments? For one thing, a primary residence is a "consumable." You have to live somewhere, and when you sell one home, you'll likely use the proceeds to purchase another. Your home may not be easy to sell, especially in today's housing market. Most mutual funds, on the other hand, can be easily sold and converted to cash. And determining the market value of your home may be difficult. Until you sign a contract with a willing buyer, you won't know the final price. Want to know the value of your mutual fund? Open today's newspaper.

A home is also expensive relative to mutual funds. Each year, the cost of maintenance, property taxes, and homeowners insurance might equal 3% or 3.5% of your home's value. When you want to sell, moving costs, lawyer's fees, and commissions can easily eat up 5% or more of your home's selling price. Holding and selling shares in a mutual fund will generally cost less.

Is a home an investment or simply a place to live? It may be both. But think twice before treating home equity as part of your investment portfolio.

March 2012

Save on pet costs

Studies have shown that over 60% of all families in the United States own a pet, and pets aren't cheap. The cost of basic food, supplies, medical care, and training for a dog or cat often runs $700 to $875 annually. Add to that surgeries, grooming, kennel boarding, and miscellaneous costs, and you may end up spending $10,000 or more to keep your pet healthy and happy throughout its life. Fortunately, many of the costs associated with responsible pet ownership can be controlled or at least reduced. Here are a few ideas.

Buy a mutt. Besides being cheaper, mongrel pets often have fewer health problems than purebreds. One study found that caring for a mixed-breed dog was about a third as expensive as caring for a pet with a sterling pedigree.

Get it spayed or neutered. Animal shelters often provide this procedure at relatively low cost. Unless you want to open a pet store, this step should be first on your to-do list. Getting your dog or cat "fixed" may also mean fewer health problems down the road.

Buy food in bulk. For most pet owners, food is their largest ongoing expense. So reducing that cost often generates the greatest savings. Although big-box retailers offer substantial cost reductions for large quantities of pet food, it always makes sense to shop around. (Specialty stores have sales, too.) Generally speaking, the more you buy, the cheaper the food. But be careful. Though there's no legal definition of "premium" in terms of pet food nutritional quality, think twice before grabbing the cheapest bag off the shelf. Long-term health problems may result from routinely feeding non-nutritional meals — food that's mostly filler — to your dog or cat.

An ounce of prevention... Regular exercise and routine veterinary visits often reduce long-term health care costs. And don't forget their teeth. Severe gingivitis may lead to serious health problems in your pet, including kidney and lung disease. If you don't want to brush your dog's ivories, consider dental chews that release teeth-cleaning enzymes.

Go cheap on toys. Shopping at your local dollar store can save lots on balls, chew bones and all those other baubles your pet adores.

Go slow on pet insurance. Budgeting and contributing to your own "pet emergency fund" may be cheaper than paying insurance premiums. Do the math before buying.

February 2012

What you need to know about life cycle funds

Like the college student who refuses to consider his impending entry into the labor market, many Americans take a head-in-the-sand approach when it comes to retirement planning. They don't contribute enough to 401(k) plans, and they don't periodically rebalance their investments to protect contributions and generate a reasonable rate of return.

One recent solution to this dilemma is the advent of life cycle or target date funds. Also called age-based funds, these funds contain holdings in other mutual funds. In other words, they're "funds of funds." In some cases, firms automatically contribute a portion of an employee's salary to the company retirement plan, and life cycle funds are the default depository for such contributions.

If you've set aside money in a 529 savings plan for your child's college education, you might be familiar with the concept. When an employee is just starting out, the target retirement fund might invest 80% of its assets in stock-based mutual funds and only 20% in more conservative funds. As the employee progresses toward retirement, the mix changes. A life cycle fund for an employee in his 60s might invest 60% of its assets in bonds and other relatively conservative investments, while only 40% might be allocated to stock funds. Life cycle funds put portfolio rebalancing on autopilot. The fund manager tracks the allocation of stocks and bonds, and makes adjustments as needed to meet predetermined investment objectives based on target retirement dates.

Although putting your retirement investments on autopilot might sound like a great idea, this approach also has some significant drawbacks. For one thing, contributing to a garden variety index fund may be cheaper because you don't have the expense of managers who periodically rebalance your investments. Also, including a life cycle fund in a broader investment portfolio may make it difficult to determine your asset mix at any point in time. If you know, for example, that your 401(k) is invested in a Standard and Poor's 500 index fund and a fund consisting solely of U.S. Treasury bonds, it's relatively easy to know how much of your money is invested in stocks and bonds. Adding a life cycle fund to the mix, with its fluctuating holdings of more-or-less conservative and risky investments, can muddy the waters and make portfolio management tricky.

Still, life cycle funds may make sense for you. Just be sure to verify that your autopilot is still on course.

January 2012

Answer four questions before refinancing a mortgage

"Interest rates hit historic lows!" "Refinance Now!" "No-cost refinancing!" These advertisements urge consumers to capitalize on mortgage interest rates that have declined significantly over the past two decades. In December 1991, the average rate on a 30-year mortgage was about 8.25%; now it's about 4%. That said, mortgage refinancing doesn't make sense for everyone. Before you rush to your bank or online lender, be sure to answer these four questions.

How much will it cost to refinance? In a refinance, you pay off the old mortgage and acquire a new mortgage. Most of the costs associated with the original loan — for appraisals, title insurance, loan origination, credit reports, home inspections, and so on — will be charged for the new mortgage as well. Even if your lender offers a "no-cost" refinance, such costs will probably be rolled into the new loan or factored into the new interest rate. "No cost" isn't really no cost.

How much time is left on your existing mortgage? If you're nearing the end of your existing mortgage term, refinancing may not make sense. That's because the bulk of current payment is being used to reduce your principal balance. As a result, lowering your interest rate may not result in savings (after refinancing costs are considered). On the other hand, if you still have many years to pay on an existing mortgage, acquiring a new mortgage with a lower interest rate may indeed save thousands of dollars.

How long will you stay in your home? Say you get a lower interest rate that shaves $150 off your monthly payment, but you stay in the home for just one more year. Does it really make sense to pay $4,000 to refinance your existing mortgage? To recover refinancing costs, you would need to enjoy those lower payments for over two years ($4,000/$150 per month = 26 months).

Will you cash out your equity? Some homeowners refinance a mortgage to get cash for remodeling kitchens, paying off credit cards, or taking vacations. That's not always a great idea. Let's say your home is worth $200,000 and you have a $150,000 mortgage. That means your equity is $50,000. If you cash out $30,000 of that equity and, as a result, your refinanced mortgage increases to $180,000, your payments and long-term costs may escalate as well — even with a lower interest rate.

For help in analyzing the refinancing issue in your situation, contact our office.