Seven Laws on Managing Money Remain Unchanged

Twenty years ago, I sat down at a Royal typewriter in the Harrison Avenue offices of the Boston Herald American. It was my first job at a newspaper, and I wrote my first 700 words as a newspaper personal finance columnist. It was like coming home. That was more than 3,000 columns and 2 million words ago, all written during a period of massive change. It has absolutely not been one year repeated 20 times. Then, The New York Times was calculating how long it would take Saudi Arabia to buy all the stock on the New York Stock Exchange. Later, others worried Japan would do much the same, starting with our favorite golf courses. During that period, the investment world has sprouted mortgage securities, an entire universe of derivatives, discount and deep-discount brokerage, financial planning, variable annuities, 401(k) plans, variable rate mortgages, and the number of mutual funds has grown from a mere 427 to more than 7,600. Where in 1977 I worked on a Royal office typewriter and was proud to be adept with a financial calculator, I now work on a personal computer with more power and better tools than mainframes from the ’70s. I can spreadsheet, array and optimize. I can access, screen and sort massive databases that didn’t exist 20 years ago, or were available only at a massive annual cost to institutional investors. More important, virtually all of the tools I use in this column are available, at reasonable cost, to readers. You and I can now “do” our personal finances. And we can make them very, very complex. We can visit the local bookstore and peruse 900-page tomes that booksellers should market by the pound. We can also read books with only 300 or 400 pages on the nuances of options and other arcane financial arts. We could do that. But it wouldn’t make a lot of sense. The basics of personal finance are T-shirt simple. They were T-shirt simple 20 years ago, and they are T-shirt simple today. Master them and your financial future is assured. We can capture it all in seven “laws.” Hey, they might even be immutable: -Spend less than you earn. Millions of people still don’t grasp this simple principle, choosing instead to believe they can borrow their way to security and wealth. Unless you spend less than you earn so that you have money to invest all talk about personal finance is fruitless. -Make your saving automatic. Saving can’t be something you do with money that is “leftover.” There is no such thing as leftover money. Saving has to be as real and constant as buying food or paying the mortgage. The best way to do it is to arrange your finances so that you never see the money. That means using a 401(k) plan to the hilt, if you have one, or at least arranging for automatic withdrawals to an investment account -Take free money. Many people who would drive miles for a store sale routinely leave easy money on the table: They don’t take advantage of company-provided 401(k) plans or 403(b) plans. The first benefit is tax savings; the second benefit is the money frequently contributed by employers. -Keep the return on your money. Share as little as possible with the tax man. And be tight-fisted with your commission or advisory dollars. Getting a high return on your investments is good for you only if you get the return. If you get the risk and someone else gets a guaranteed return, you’re losing money. -Owe as little as possible. There was a time when owing money was a good idea. That time is long gone. Mortgage debt should be paid off in 15 years or less; nondeductible debt should be avoided or paid off as soon as possible. -Tend your own garden. The favored selling illusion is that someone else, somewhere else, has opportunities that are not available to regular folks. We have limited control over the return on our investments; we have great control over the amount of money we invest. Concentrate on what you control. -Trust the power of average. For those who want great wealth, competition for the highest returns is essential. For the rest of us, it is necessary only to participate in the broad creation of wealth. That means favoring index investments, unless there is a compelling case to “bet” on a particular competitor in the contest of creating wealth. Question: I have a few questions about a first-time home purchase. I’m a single, 28-year-old male making $4,500 a month. I’m looking to purchase a home for about $135,000. I currently rent a condo for $800 a month and have a $286-per-month car payment for 26 more months. I’m virtually debt free, except for monthly bills and a credit card bill that I pay off each month. Currently, I have $4,000 in checking, $2,000 in savings, $1,650 in a Roth IRA and $25,000 in a traditional IRA. I switched companies last year, so I will not be eligible for a 401(k) until this summer, at which time I will contribute 10 percent. I also plan on contributing $2,000 a year to the Roth IRA. I hope to roll the traditional IRA into a Roth someday. What do you think? It is probable that I will receive a cash “gift” of about $6,000 to $8,000 for a down payment. What are my best options? C.B., Findlay, Ohio Answer: First, give careful consideration to becoming a home owner, because the tax benefits won’t be as large as you’d like to believe, and the transaction costs for selling can be damaging if you sell in a short time. Let’s work through the numbers. While your price range is prudent, the monthly payment on a $121,500 mortgage (the amount you would borrow after a 10 percent down payment) is $891.52, if you can borrow at 8 percent for 30 years. That will give you interest deductions in the first year of about $9,700. If the real estate taxes are 2 percent of the sale price (a typical rate in much of the country) you’ll also have an additional deduction of $2,700 for a total of $12,400. Most people thinking about the tax benefits of home ownership multiply this number by their tax bracket, often 28 percent, and figure their tax savings will be $3,472 a year, or nearly $300 a month. In fact, a single taxpayer has a standard deduction of $4,400 (vs. $7,350 for a married taxpayer filing a joint return), so the actual tax benefit nets to $2,240, or a bit less than $200 a month. (Only itemized deductions in excess of the standard deduction will reduce your tax bill.) In your case, the tax savings, even at only $200 a month, will work to offset some of the expenses of owning such as a higher mortgage payment, insurance and real estate taxes. My suggestion: If you have to empty a Roth IRA account to get the down payment and closing costs together, delay buying. Don’t, however, worry if you can’t make a Roth IRA contribution in the first year after buying. Questions about personal finance and investments may be sent to Scott Burns, The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265; or by fax: (214) 977-8776; or by e-mail: [email protected]. Check the Web site: www.scottburns.com. Questions of general interest will be answered in future columns.