THE FINANCIAL CONNECTION
Q&A WITH SUZE ORMAN
Improving your lot may not be wise
My husband and I are in our mid-30s.
We are obsessed with doing home
improvements that are cutting into our
equity and increasing our mortgage payment. Our goal is to have a beautiful home.
Is this a wise decision?
Anaheim Hills, California
You are letting your emotions get the better of your finances. Can you really afford
those higher mortgage payments? You might
be paying the mortgage every month, but that
doesn’t mean you can afford it.
I bet you and your husband aren’t contributing the max to your company’s 401(k)
or investing in your own IRA. I have this
awful feeling that your credit-card balance is
getting mighty big as you charge away to put
beautiful new things in your beautiful home.
And do you have an emergency-cash
fund that would cover at least six months or
so of living expenses? What happens if one
of you suddenly becomes ill or unemployed
and your family income drops? If you can’t
keep up with the mortgage payments, your
beautiful home won’t be yours anymore.
Let’s talk about the real estate market. Are
your home improvements making your house
the spiffiest on the block? If so, it can be
harder to sell. Buyers want the best value in
the neighborhood, not the priciest house.
Also, do you intend to stay in this house
forever? If you’re like many young home-owners, you will probably be trading up
sometime down the road. You should build
up equity so that when you do sell you will
make a nice profit that can be a down payment on your trade-up.
So put down the miter saw and step away
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from the drywall. Take a deep breath and
look at the big picture (not the picture window of your dreams). If your obsession is
causing you to make bad financial choices,
you need to improve your investing and saving habits, not your home.
My wife and I are in our mid-40s. We
save about $115,000 per year. We
have $600,000 invested in money-market
accounts, earning 2 percent interest. Is it
foolish to be this conservative? Should we
be investing more aggressively?
Nassau County, New York
Good for you! Saving $115,000 is terrific. The credo of so many people is: The
more you make, the more you spend. But you
obviously have a far better credo: The more
you make, the more you save.
How much money are you willing to
risk? If you decide that you have $100,000
you are willing to invest, put it in the stock
market. I suggest you systematically put the
money to work over several months, using a
strategy called dollar cost averaging.
Here’s how: Take whatever amount you
decide to invest and divide it by 12, then take
that one-twelfth and invest it every month in
the same investment. As long as the investment is fundamentally good, just keep up
with the monthly investment. Over time,
when the shares go down your dollars buy
more shares, and when the shares go up you
buy fewer. The idea is that your average cost
is going to be less over time, and that puts
you in position for bigger gains as you let
your money grow over at least 15 years.
If investing in the stock market is going
to keep you from sleeping, an alternative
strategy is to boost your current return by
investing in bonds rather than money markets. I think you could easily double your
return to about 4 percent tax-free by investing
in high-grade municipal bonds.
Because interest rates are beginning to
rise, I would recommend using a bond ladder
strategy. Put maybe one-third of the money in
municipal bonds with a very short maturity
of one or two years, another third in bonds
with a maturity of three or four years and the
rest in bonds that mature in five years or so.
When each bond matures you can reinvest it
at the current market rate—which will probably be higher than it is today.
I calculate that, by investing your money
in tax-free bonds averaging just 4 percent,
after 20 years you would have more than $4.7
million. At $4.7 million you would earn about
$200,000 a year in tax-free interest per year
(assuming a 4 percent return). If that is enough
KEI TH LATHROP
to meet your needs once you include any other
income such as retirement accounts, then, my
goodness, feel content to be conservative.
Iam 61 and recently widowed. I have a
mortgage balance of $22,000, a car balance of $25,000 and a credit-card balance
of $11,000. I just received a life-insurance
settlement in the amount of $50,000.
Which of these outstanding debts should I
Bronx, New York
My advice: Get rid of the credit-card debt,
assuming you are paying some obnoxious
interest rate of 10 to 20 percent. There is no bad
time to get rid of such a costly debt payment.
I also would get rid of the car loan—and
never take out another one. Cars are a depreciating asset, not an appreciating asset. If you
can’t afford to pay for a car with cash (or at
least make a hefty down payment), you can’t
really afford the car.
Now you have $14,000 left. You should
sit tight for up to a year. If a year from now
you decide you want to stay put, then you can
consider using the remaining $14,000 to pay
down the mortgage.
Before you spend all of that insurance
payout, make sure you have a cash emergency fund. If not, the $14,000 should go for
that. Then, if you want to start taking early
Social Security distributions next year—you
are eligible at 62—you can use some of that
cash to pay off your mortgage faster. C
Suze Orman’s latest book is The Laws of
Money, The Lessons of Life. She is the per-sonal-finance editor for CNBC. For more on
Orman, go to www.suzeorman.com.