I live with someone who is incredibly smart (ivy-league doctor). Read the 7 examples that lead me to believe that she is not financially smart.
1. If she has money, she will invest. If I see a good investment opportunity, I will think about how to ‘fund’ it. Like other financially smart people I have learned to say How?
2. She does not understand the time value of money – she always lends me money interest-free when we play Monopoly. And then she wonders why I always win – because I will buy every property that I can on the board by taking money from her (or the bank) interest free. Financially smart people are always on the lookout for interest free money.
Keep in mind the following though:
a. High interest debt like credit cards is a suicide but interest free debt is a blessing if invested properly. Read a related post here.
b. Do not over – spend because the seller is offering you an interest free loan. Interest rate should not dictate your purchase size in this case.
3. We own a house that we are in the market for refinancing right now. We got the original mortgage in 2014 (0% down payment). When we talk about refinancing at 100% LTV or pay down 20%, she often talks about ‘But the house might be worth much more in 5 years?’
She seems to think that the house appreciation will benefit us more if we make a down payment. While I know that the house appreciation will benefit us exactly the same amount whether we put nothing down, or 20% down, or even 100% down (pay off the mortgage).
We own the house, irrespective of whether there is mortgage on the house or not. Our equity in the house depends on how much mortgage do we owe to the lender, but our exposure to real estate is the entire value of the house (irrespective of the mortgage amount).
You will see other variations of this problem too – and sometimes even financially smart experts get confused. Here is a good example:
Here a couple would like to plan for an early retirement and the Number 1 personal finance magazine in the country advises them:
The equity in the rental property does not matter (as far as the impact on net worth is concerned). Let us say two examples assuming the rentals are worth $200,000
- Equity of $78,000 and debt (mortgage) of $122,000
- Equity of $50,000 (and the rest $150,000 is mortgage)
When/ if the real estate market crashes and the value of property falls to say $160,000 – the couple has lost $40,000 from what they own today (irrespective of the debt/ equity ratio).
In case 1, the equity falls to $38,000 and the mortgage is still $122,000 -> so net, they ‘owe’ $84,000. Actually look at it this way -> you owe the bank $121,000 and your property value is $38,000. So now you owe net $84,000.
Earlier you owed $122,000 – $78,000 = $44,000. You have lost $40,000
In case 2, you owe $150,000 to the bank and the equity falls to $10,000 -> so the net you owe is $140,000. Earlier net owed was $150,000 – 50,000 = $100,000. So you lost $40,000.
To summarize this point – the couple owns rental property worth $200,000 -> and they will gain/ lose the entire amount by which the property increases or decreases in value. The amount of equity does not matter.
The other problem with the above expert advise is “sell rentals when you have difficulty finding tenants” – I would say NO, that will be too late. Selling the rental now when it is a turnkey investment might give you a good selling price rather than waiting for the real estate market to go bad before selling it.
4. She was unhappy that she did not get any refund while her colleagues got tends of thousands of dollars back.
She does not explicitly realize the fact that she was getting less taxes withheld during the year so essentially what her colleagues are getting back now, she has been getting all along with every paycheck.
Hopefully she will appreciate taxes due vs tax liability difference some day soon (else I will start to consider myself a failure lol, just kidding).
5. She hated debt and was paying off her student loans as fast as she can – this works great in 2 situations: if you have money then you will end up spending it rather than investing it and if the debt is high interest rate.
She was paying down her loans that had an interest rate of 2% while I take as much loan as possible as I can get at 2%.
The reason – I am confident that I will make much more through my investments. How much more? I am hoping that I will make about 8% over long term.
But debt is risky and since 8% is uncertain, I will not take debt at say more than 4% to speculate. If someone is loaning me money at 2%, then I will surely take it. If someone is giving it to be at 5%, then I will definitely not take it.
For things like 3-4%, I will have to run specific numbers (using my Excel).
6. She was not claiming her mother as a dependent, I made her file amended returns for three years, got back $3,000 in refund each year. This money is not all that much given what she earns today but this was a hell lot of money when she was doing her residency and earning $50,000 a year.
Her CPA never asked her and she never mentioned it. I wish she would have met me sooner. One of the main reasons I urge people to understand taxes is for situations like these: a CPA will only know what you are telling them, sometimes they will not ask you the right things because they do not know your situations.
7. She was about to buy a car for $42,000. I asked her ‘Will you wait 10 days if I get it for $5,000 less’? She said – yes. 10 days later, we bought the exact same car for $36,000. We saved $6,000.
More on car buying negotiation techniques some other time, but essentially I negotiated the price of the car down to $36,000 from $42,000. I was able to do so because I was not in a hurry – I got multiple quotes from multiple dealers and essentially made them bid against each other.