He had his eye on some land.
“Daddy always said land was a smart investment. I think so too. They’re not making any more of that,” he said with a smile.
“I could borrow the money,” he continued. “But I look at those amortization tables, and it kills me to see how much interest I’d pay.
“My other option would be to use all the money in my investment account to buy the property. That way, I could pay cash and avoid paying interest. What do you recommend?”
Financial questions like this are always tricky. The one thing I always want clients to avoid is being one-dimensional in their thinking.
Looking at only one part of your total financial situation gives you a distorted picture. You can end up like the guy who was frantically bailing water out of the front of his sinking rowboat—and pouring into the back!
Take a property transaction like the one above. Say you borrowed $100,000 to buy a small piece of land. At 4% interest over 20 years, your bank will expect 240 payments of about $606. That comes to $145,435 total—basically $45,000 in interest to purchase a $100,000 piece of property.
Now who in their right mind wouldn’t want to avoid paying that $45k?
Hmmm…maybe the person who sees the bigger picture.
Here’s what I mean. Remember the other option: Emptying your investment account to buy the property outright for $100,000? That would save you $45,000 in interest. But how much would that move cost you in interest?
No one can predict what an investment—whether land or money in the markets—will do over the next 20 years.
But let’s say your investment account grew by an average of 5% annually over the next 20 years.
By buying the land with borrowed money (as described above)—in 20 years your investment account would be worth about $270,000, and you would own the land too.
If you liquidated your investment account to buy the land, at the end of the 20-year period, you would own the land, but have zero in your investment account. Unless…
You were shrewd. What if, since you never borrowed money from a bank, you decided to pay the same $606 per month (that you would have been paying for a bank loan) to your depleted investment account.
At the same 5% rate of return, that $606 per month discipline every month for 20 years, would amount to almost $250,000. Nearly, the same amount you’d have had by keeping your investment account intact and taking out a mortgage.
That’s how the math plays out. What about real life?
My experience is that people borrowing from a bank would almost certainly pay the $606 per month land note. That’s because failure to do so would result in foreclosure.
But only highly disciplined people would stick with a voluntary saving plan of replenishing their investment account to the tune of $606 every month for 20 years.
Do you see? One choice puts human nature on your side. The other pits you against it.
In short, I’m saying there’s often not an obvious “right” answer to financial questions like this one. That’s because life isn’t one-dimensional. Finances are more than mere numbers.
Always do the math. But just as important is to consider is the human element, the “me” factor. What are YOU most likely to really DO in the end?
Answer that, and you have your answer.
And as you “run the numbers” and look at options for your financial future, consider this: I’ve created a comprehensive checklist of pre-retirement questions for people who are 60-something. It’s free if you’d like a copy. Just email me at firstname.lastname@example.org, and I’ll send it to you right away.
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