Friday, April 8, 2011

Criminal Financial Planner?

 In this brilliant piece, entitled "Should You Pay Off Your Mortgage or Invest?", Kelly Campbell, a Certified Financial Planner attempts to answer the question.  It's a very hard question to answer, especially depending on a number of particulars for some households.  (I could go on for hours about this for my household...)

Campbell's attempt to answer is so bad, she should be...I don't know, not published by US News and World Report??

Assume a $500k house, $450k mortgage at 5%, real estate returns 5%, other investments return 8%, and you have a 25% tax rate.

Here's her analysis:
Scenario 1: You pay off your mortgage. Since there is no loan, and no investment other than your house, both your investment money and your house value increase at 5 percent (the rate of return on real estate). Your total increase is $25,000.
Scenario 2: You owe $450,000 (90 percent of your home's value). In this scenario, you have a $450,000 note with a 5 percent interest rate. The cost to you is $22,500 per year in interest. But since you are able to deduct the interest on the note, the real cost, assuming a 25 percent total tax rate, is $16,875 per year.
Remember, you will also have the $450,000 that you would have used to pay off your mortgage invested. Assuming the above 8 percent return on investment, this will give you a return of $36,000. Net out what you make and what it costs--$36,000 less $16,875--and you earn a $19,125 return each year.

Brilliant!  If you borrow money to invest, and prices rise, you make more money.  If they don't, you have a problem.  Her closest concession to reality: "It's very important to have investments capable of achieving an 8 percent return..."  Holy cow, that's an understatement!

Should we be surprised?  Probably not.  I am sure Ms. Campbell has many clients asking a very reasonable question: "Why am I giving you money to manage when I could simply pay down my mortgage?"

That's a complicated question that can be very hard to answer.

I guess the easy answer: The Campbell household needs to eat too.

1 comment:

  1. I have read this several times, and am missing your point. Which option are you advocating? I for one would opt for the pay off, since this is the lowest risk, and would allow me to keep my home if the economy ranks again.