Expert: Steve Hach - 5/27/2008

Question
QUESTION: "Hello, my late uncle left me 7 million dollars which was a solid transfer from his bank to my bank. At the present time I'm a $125,000 in debt due to my recent diagnose of cancer and we went from 2 incomes to one income. Before I became sick my take home pay was about $6 -7 thousand a month and my husband take home a month is $4000. Debt begin to pile as we lived off credit cards and spent money on treatments, medical bills, and living expenses.



My first goal is to pay off everyone and everything.



At the present time we're renting a home for $1300 a month.

My second goal is to use part of the money to purchase a home in full, meaning no monthly payment. I'm looking to spend under $500,000.



My third goal is to:

Put away towards an emergency fund.

Put away money for our two children.

Put away money for my retirement & my husband.

To invest the remaining amount.



I'm looking for a very good investment firm to work with. I've heard the bigger the firm the better. Are monthly fees tack onto obtaining help to manage your funds or portfolio?



Where can I search and find a list of large investment firms to work with? Do you have any in mind. I here a lot about Edward Jones? Also, I here its best to work with a registered investment company?



Can you please help?



ANSWER: Hi Sherry,

sorry about the delay in my reply,

long weekend and all.

Here's is what I think about your situation:

You are in an enviable situation.

You have the right plan for the money.

A few thoughts,

1.  Make sure your owning vs renting situation is really going to save you money.  Housing costs have been in steep decline.  People have bought houses only to see them drop 20% or more in value.  Make sure this market is stable and that it really is cheaper to buy rather than rent before you lay down 500k for a home.  

For someone with your capital, it may make more sense to rent rather than buy if you can put the money to work in more profitable investments.  You are NOT in a position where your home must be a forced savings plan.  You might also consider a smaller condo or something.

2.  Pay the high interest debt first--such as credit cards.  Stop using credit cards and live within your means.  If you can continue to live at your old level of spending and do not escalate that spending to match your new wealth, you will be better off.

3.  Consider some sort of trust arrangement to preserve the lion's share of the capital for you and your children.  This may provide better tax benefits for all parties.  You mention that you will put away money for children, retirement, emergencies, etc.  I would suggest that you pay off debts and then invest ALL of the money.  The proceeds of those investments then become the funds for the emergencies, kids, retirement, etc.  Investing a larger amount of the capital will lead to larger returns and lower risks--you can be more conservative with such a large amount.

4.  Be very careful in your selection of an investment advisor.  I am not sure "more expensive is better."  The important thing is to find someone you trust.  It is possible to manage things yourself if you are willing to educate yourself and make your own moves.

5.  All of the advisers will charge fees for all services.  This is why  I mentioned the possibility of doing things yourself.  The odds are the adviser is just going to put you into a bunch of mutual funds and other products sold by her company.  These will all involve fees. Their job is to make money off of you and your money.  Never forget that.  Also, be very wary of any adviser that "guarantees" a certain return.

I hope this helps, and sorry again for the delay in my reply.

Best,

Steve  



---------- FOLLOW-UP ----------

QUESTION: Thank you for the advice. But, don't you think it will be better for me to purchase than rent. Yes, it's a very large purchase but at the same time this will be our final purchase. I have heard so much about the market and how some say go ahead and buy and others say just rent for now.

But, if a person is looking at this as a long term investment, wouldn't it just be better to purchase?
We're looking for this to be our final and last move. I have a friend who is in a similar situation where she purchase a condo instead of a home, now she feels as if she's stuck with a bad decision of listening to others and her condo is just sitting on the market.

Another reason I thought about purchasing is because home prices shoot up every year regardless of the market. If you want to get into a great location, with excellent schools and community than you will always have to pay top dollar. We're looking to settle in San Antonio a city in which we love and the job opportunities and growth for nurses there are through the roof. Although, I have inherit such large amount of money I'm still looking to work both my husband and I. Our 2 children already have education accounts setup for them and we're looking to put 1 million in each account. Do you think that will be wise? Also, we're looking to put 1 million in each of our retirement accounts. Do you think that will be wise? We're looking to keep 1 million in our regular savings/emergency fund account. Do you think that will be wise? But, before we do anything we're going to pay off our $150,000 debt which includes both of our cars.

I thought about hiring a financial advisor to set up a Portfolio for us but at the same time we already know what we want to do with the money and how we want to invest it. So, should we still hire someone to handle our funds, especially since these accounts are already set up and we're just adding funds to them?

Answer
Sherry,

I wanted to add the following to this answer....

here is a link to an article in the NYT that succinctly dissects the issue of renting vs buying.

http://www.nytimes.com/2008/05/28/business/28leonhardt.html?_r=1&oref=slogin&pag

IF you go here:
you will see a chart that has all of the rent/buiy ratios for cities--including san antonio:

http://bigpicture.typepad.com/

article follows too:


May 28, 2008
Economic Scene
As Home Prices Drop Low Enough, a Committed Renter Decides to Buy
By DAVID LEONHARDT

For the last few years, I have been an evangelist for renting.

I’ve told my sister-in-law and her husband that they would be crazy to abandon their reasonably priced one-bedroom rental in Brooklyn. When two of my colleagues were moving to Los Angeles, I e-mailed them a spreadsheet that helped persuade them not to buy a house there. That same spreadsheet was the basis for an article in 2005, when I argued that “renting has become a surprisingly smart option.” Last spring — like any good evangelist, comfortable with repetition — I wrote a similar article.

The case for renting has been simple enough. House prices rose so high in the first half of this decade that you could often get more for your money by renting. You could also avoid having a large part of your net worth tied up in a speculative bubble.

All this time, I have been a renter myself, first in the New York suburbs and then in Manhattan. But my wife and I will be moving to Washington this summer. And the housing market has, obviously, changed quite a bit since our last move, in 2005. Nationwide, prices fell 14.1 percent from early 2007 to early this year, as Standard & Poor’s reported Tuesday. Home prices almost certainly still have a way to fall, but they’re now well below their peak.

So my wife and I began our search with open minds, willing to consider renting or buying. We ended our search by signing a contract to buy a house.

This is the story of my conversion.

One of the big lies of the real estate business is the idea that renting a home is tantamount to throwing money away. It’s a useful fiction for real estate agents, because they make vastly bigger commissions on house sales than rentals. But the comparison isn’t nearly so straightforward for the rest of us.

Renting involves one obvious, recurring cost that can never be recouped: the monthly rent check. Buying, on the other hand, involves multiple expenses, some of which aren’t so obvious. On top of closing costs, there are repairs, property taxes, mortgage principal and mortgage interest. (The mortgage-interest tax deduction reduces this last cost but doesn’t eliminate it.) When you own, you also lose the ability to invest your down payment elsewhere, like the stock market.

Of course, owning also brings benefits that have nothing to do with money. You can settle into your home, confident that no landlord will kick you out. You can repaint the walls and redo the kitchen. All else being equal, owning seems far preferable to renting.

Knowing all this, my wife and I were willing to buy a house even if it was ultimately going to cost us a bit more than renting. We just weren’t willing to have it cost a lot more than renting.

Over the last several years, I’ve come to like a simple, back-of-the-envelope way to compare the costs of renting and owning. You find two similar houses, one for sale and the other for rent, and divide the sale price by the annual rent. You can call the result the rent ratio.

The concept will probably sound familiar to stock market investors. It’s the real estate market’s version of a price-earnings ratio — a measure of how expensive an asset is, relative to the underlying economic fundamentals. Like a P/E ratio, the rent ratio provides something of a reality check.

Throughout the 1970s, ’80s and ’90s, the average rent ratio nationwide hovered between 10 and 14. In the last few years, though, it broke through that historical range and hit almost 19 by the time the housing market peaked, in 2006.

And while home prices — and rent ratios — have always been higher on the coasts, they reached whole new levels recently. In the Washington area, the ratio went above 20. In Boston, New York, Los Angeles and south Florida, it topped 25. In Northern California, it approached 35, higher than it had been in any city, at any point on record.

In concrete terms, a rent ratio above 20 means that the monthly costs of ownership well exceed the cost of renting. At current mortgage rates, for example, a $500,000 house would typically bring monthly expenses of about $3,000 (taking into account taxes, repairs, a typical down payment and, yes, the mortgage deduction). When the rent ratio is 20, that same house could be rented for only about $2,000 a month.

There are two problems with buying a house in this situation. The first, plainly, is the extra $1,000 you’re paying each month for the privilege of owning, on top of the thousands of dollars you spent on closing costs. The second problem is that a rent ratio above 20 is a good indication of a bubble. When the prices of houses get out of line with the competition’s prices — that is, those in the rental market — a correction is coming.

The question facing my wife and me was whether we were entering the market before the correction had gone far enough. I really didn’t know what the answer would be. So as we looked at houses, I started calculating rent ratios.

In the neighborhoods where we were looking, two-bedroom condominiums were selling for $400,000 and being rented for about $2,100 a month, which makes for a rent ratio of 16. Four-bedroom houses were selling for $700,000 and being rented for almost $4,000, which makes for a rent ratio of 15. No matter the price range, pretty much every apples-to-apples comparison produced a similar ratio.

Historically, this is still a bit high. But it’s very different from where the market was just a couple of years ago. With house prices having fallen over the last two years and rents continuing to rise, the decision became a much closer call. We would now have to spend only a little more each month for the privilege of owning.

This month, we found a house that we really liked, and we made an offer. It was accepted.

I’m still not sure how good our timing was. Based on the backlog of houses on the market, I fully expect that our new house will be worth less in six months than it is today. I’m also not sure that we would have been willing to buy in Boston, New York or much of California, where the rent ratios remain above 20, according to data from Moody’s Economy.com.

In fact, if you’re now renting — almost anywhere — and do not need to move, I’d probably recommend that you wait to buy. The market is still coming your way.

But it’s O.K. with me if our timing wasn’t perfect. After several years of reporting on the housing market, I’m convinced that the most common real estate mistake is viewing a house first as a financial investment and only second as a home. That’s one big reason we ended up in this bubble-induced mess.

Most of the time, the decision whether to rent or buy should be based above all on life circumstances. Do you expect to move again in a couple years? Or is there a good chance that you’re ready to settle in — and stop worrying about real estate for a while?

The housing bubble, unfortunately, forced a reconsideration of this standard, because houses became so overvalued. But they’re slowly coming back to reality, which means that buying has again started to make sense for more people. Apparently, I’m one of them.

E-mail: leonhardt@nytimes.com

You say this:

"home prices shoot up every year regardless of the market."

This statement is simply NOT true.  In fact, home prices have been declining recently and in some areas they are down in excess of 20%.

Prices do NOT "always go up."

Believing such things is why there are many people in real financial trouble right now.

Just because you want to hold the house long term, do you think it is wise to buy one that may decline 10-15% in the first year?

It would be wise

Also, could you please explain what school your children will attend that they will each need $1,000,000 to do so????

In my mind, giving a teenager/young college student such a large amount of money is courting trouble.  

As I noted, it may be best to speak with a lawyer about setting up a trust that will provide each member of your family some sort of income for the rest of your lives.

In my view, it may be better to preserve that capital in toto by setting up a unified account that pays for everything--retirement, emergencies, education, etc.

If you already have accounts for each person and you want to make things easy by just dumping more money into them, then that may be fine, but I still recommend finding a lawyer that you trust and discussing the creation of a trust.

It may provide superior tax advantages, guard against your children irresponsibly squandering the money, etc.

Best,

Steve