Purchasing property is one of the ways that you can let the world know that you have arrived. Some may see it as a way to let others know that you have your feet under you, that you manage your income, and that you are responsible enough to manage a household. However, it is important to keep in mind that although home ownership can be seen as a step in the right direction, the price of your home can drastically impact your financial trajectory. Just how much, comes down to your monthly savable dollars, and where you end up allocating those dollars over the next few decades of your life. The key things you should be thinking about are, how much cash flow do I need to sustain my lifestyle? How much do I want available for an emergency? Am I “house poor” with too much allocated to my home? Let me walk through some specific examples. Having a lower monthly mortgage payment may provide you the ability to save significantly more money. The increased savings may allow you to allocate more towards your investment accounts.
Conversely, if your monthly mortgage payment is larger, more of your income may be going against a mortgage with a low interest rate. That is why some people say to consider not paying down your low interest primary mortgage too quickly. Rather, consider allocating those additional dollars to a potentially higher yielding investment account. This raises the question of opportunity cost and whether your money is better off paying off your existing mortgage or instead, investing those dollars in the markets.
Why own? You may ask. There are a couple of financially beneficial reasons for home ownership. One of them is the tax deductibility of the mortgage interest you pay every month. Your mortgage interest is tax deductible dollar for dollar up to a maximum of a $1 million mortgage. On a $500,000 mortgage, you could save roughly $500 per month that would otherwise be paid to Uncle Sam. The exact amount you’ll save will depend on your income tax bracket, the interest rate on your mortgage, along with other factors.
Another reason people purchase property in their 30’s is to one day have a house that is completely paid off, therefor relieving themselves of a mortgage payment. It is very common to have a thirty year mortgage on a property, which would mean the property would be paid off at some point in your sixties. This plan leaves only a property tax bill and insurance to be paid during retirement. Another huge advantage to home ownership in your 30’s is the ability to magnify your down payment dollars and participate in the property’s potential appreciation, which would include the dollars borrowed from the bank. Real estate is one of the few areas of your financial strategy where you have the potential to magnify your accumulation with borrowed dollars. I will add though that leveraging your real estate investment with borrowed dollars doesn’t come without serious risk. While the long term growth of the real estate market has been steady, similarly to the stock market its short term volatility is rather unpredictable. The National Association of Realtors though published a study tracking medium priced homes from 1968-2004 showing an average yearly increase of 6.4%, without a single decline during the 36-year period.* While home ownership is a personal decision, the financial gains and retirement stability that it can provide should not to be ignored. Finding the right priced home for your unique situation is vital to a successful long term financial strategy.
Your thirties are also a time when you should consider making substantial progress in your investment accounts, ultimately building your net worth. I like to call this time in your life “adulting”. While your twenties are commonly committed to finding yourself and putting in the hours required to build up a career foundation that will hopefully leave you with higher income, your 30’s should be dedicated to maxing out the common qualified pre-tax employer accounts at $18,000 per year. (2017 limit) Creating tax diversification during your thirties may pay off in the long term, possibly allowing you to avoid the higher tax brackets during retirement. There are a number of investment vehicles with which to accumulate potentially tax advantaged dollars. One of them is the common Roth IRA, however this retirement account maxes contributions at $5,500 per year and also carries income limitations. (2017 limit) The other option for tax free retirement dollars is accomplished through investment grade permanent life insurance. Because of the high cost of insurance within permanent life insurance though you must structure your policy carefully. While the primary purpose of life insurance is its death benefit, it can also possibly provide access to the cash value tax free during retirement. It’s important that you weigh your available options, and work with a fiduciary financial planner to best formulate an efficient retirement distribution plan. A healthy distribution between your pretax and after tax investment vehicles has the potential to create a sound retirement income stream, leaving you in the driver’s seat.
If you haven’t already started systematic savings into your investment accounts during your twenties, then you may be behind. Nonetheless, your thirties still allow the time value of money to have a significant impact on your investment accounts. As your 40’s quickly approach, you loom closer and closer to retirement and your contributions have much less time to compound. In other words your money has less time to work for you, and you will instead be working for your money. Let this article be a stern kick in the butt to buckle down that budget and consider increasing those systematic investment contributions now.
While a primary income stream can be a focal point to your financial success, it still leaves you vulnerable to economic recessions and other factors that are both in and out of your control. Similar to investments, this diversification doesn’t protect against income loss, but it does help spread the risk and manage income volatility. An important factor to consider is your personal time, which is finite. Many are already working a maximum number of workable hours, while still attempting to have a balanced life with their blossoming young families. What you may instead consider are passive income opportunities. A very common example of this is investing in a rental property, where the tenants are covering your monthly mortgage payment. The biggest obstacle people face when considering this option is qualifying for this additional loan from a bank. The bank will again examine your current monthly income to debt ratio, and then will determine the affordability of a second property. Another hurdle can be coming up with the high down payment for the rental property. To avoid this high down payment requirement, one may decide to instead upgrade their primary residence, keeping their previous property as the rental. In doing so, they may be required to put up a smaller down payment on their new primary residence. Finding a positive cash flow rental property isn’t always easy, and requires due diligence. You must research local rent in the neighborhood and compare it to your monthly mortgage expense, property taxes, and HOA fees. You also need to consider the depreciation of the property and how expensive the annual maintenance will be. Working with an experienced realtor who knows the area well could be a very valuable relationship.
It would appear that side businesses or even online product sales are also gaining popularity. The ease of setting up an e-commerce product with little up front capital is becoming increasingly streamlined. If the product has a unique competitive niche, it can prove to be a very successful passive income stream, with little time requirements by the owner. The ability to earn even a few thousand dollars every month can potentially propel your retirement, and is something you may wish to consider.
Each decade of your career offers unique opportunities for your personal financial growth and it’s important that you strategize and take deliberate steps to better your financial future. While these three topics are just a few of the areas to emphasize, I encourage you to reflect on them and how they could relate to your unique financial situation.
Written by Zachary MacDougall, Financial Advisor - CA# 0H70687
Diversification does not guarantee against loss. It is a method used to manage risk. Investment risks associated with real estate investing, in addition to other risks, include rental income fluctuation, depreciation, property tax value changes, and differences in real estate market values. Investors' anticipated tax bracket in retirement will determine whether or not a Roth account versus a traditional retirement account will provide more money in retirement. Generally investors who are in a higher tax bracket at retirement relative to their current tax bracket while making contributions to a Roth account benefit more than an investor who is in a lower tax bracket at retirement. For a Roth IRA, earnings withdrawn prior to reaching age 59½ and/or not meeting the five-year holding period may be subject to a 10% penalty in addition to income tax.