Robert Louis Stevenson said “Everybody, sooner or later, sits down to a banquet of consequences”. If we apply his wisdom to today’s economic situation, we’re feasting on a banquet of debt. The trick is in how we’ll digest the consequences of unsavory economic choices.
Stevenson wrote “Treasure Island” and “Dr. Jekyll and Mr. Hyde.” Two novels sharing a common theme of the conflict between good and evil. Pirates and heroes battle over gold treasure in “Treasure Island” while the duality of human nature reappears in “Dr. Jekyll and Mr. Hyde.” Bottom line — it’s all about balance, or lack there of.
Helping investors find the balance between emotion and logic and applying that to finances is what I do. An important tool used to evaluate financial health is the balance sheet, and I for one feel it’s time to put the balance back in the balance sheet.
It is perhaps a more fortunate destiny to have a taste for collecting shells than to be born a millionaire.
Robert Louis Stevenson, 1850-1894
Two plus two equals four
Somewhere along the way individuals, corporations and governments overlooked the fact that assets minus liabilities equal net worth; and that a positive net worth is a worthy goal. Negative net worth equals debt. Financing gap or liquidity crisis are the new euphemisms for debt, which is simply a consequence of unbalanced consumption. Some debt is OK, but too much can be troublesome in many ways.
Spend less, save more and invest wisely. It sounds pretty simple, but in real life it’s a tricky balancing act. Often the question is whether it’s smarter to pay down debt or save and invest. In a perfect world, we’d do both, but choices aren’t always that clear.
It’s beneficial to have plan when faced with cash management decisions. First, list your priorities in life. Next, write down existing savings and debts. Finally, create the plan (yikes, a budget!) to assist with balancing priorities with reality.
At the end of 2008 the average American household had credit card debt of $10,679 so this exercise may feel overwhelming for some, but don’t bail yet.
It’s about progress not perfection.
Weighing the details
Carrying that kind of debt works against anyone’s long-term financial health, but living without enough savings to carry you through three to six months’ expenses or more — given these uncertain economic times — may be worse. If you hold that average $10,679 credit card debt at an annual rate of 18 percent, it may take you a very long time to pay it off. At the rate of $200 a month, for example, you’ll eventually clear the debt, but it will take 9 years and cost you more than $21,000 to do so. Paying it off more quickly could save you substantial cash.
This is only a wise choice if you already have a cash reserve to fall back on in case of an emergency. Excluding mortgages, the average American is $16,635 in debt. Otherwise, you may have to dig deeper into a credit hole. In some cases, the wiser choice may be to build up savings, even as you pay down the debt.
If you have extra cash should you prepay your mortgage or invest? It’s not always a straightforward answer so be sure to run the numbers. If you have a 30-year, $300,000 mortgage at 6.25 percent with 20 years left, paying an extra $400 a month on principal could save you approximately $62,000 and cut the payoff time by nearly six years.
What if you invested the money instead? In 14 years at an annual return of 7 percent, you’d accumulate well over $100,000. Of course, any investment involves risk, and if the goal is to outdo the calculated mortgage savings, you may find yourself choosing an investment with substantial risk.
What is clear is that if you pay off the mortgage, you can determine your savings because the numbers are known. Investment results aren’t certainties.
If you’re uncomfortable with debt, prepaying the mortgage may be the right answer. But an investor with the financial discipline to invest the extra cash may choose otherwise. Don’t forget to factor in each option’s effect on your taxes.
Can’t decide? Take the middle ground. Put half toward prepaying your mortgage, half into investments. Even small adjustments can help. It’s all about balance and finding the right mix for you.
Darcie Guerin, Financial Advisor & Branch Manager, Raymond James & Associates, Inc. located at 606 Bald Eagle Drive, Suite 401, Marco Island, and FL 34145 provides this article. Gulfshore Life magazine named Guerin as one of the Best Personal Wealth Managers in The Southwest Florida Area for 2009. If you have questions please contact Darcie Guerin via e-mail at Darcie.Guerin@RaymondJames.com. Phone 389-1041, toll free (866) 343-0882 or at RaymondJames.com/Darcie. Past performance may not be indicative of future results.