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Help Your Clients Prepare for Opportunity SEPTEMBER 2007 - Some days, as I sit and watch my children and grandchildren, I can’t help but wonder what the future holds for them. My daughters are among the fortunate few to have completed their college education without accumulating the crippling debt of massive student loans. Although my husband and I don’t consider ourselves financially “rich,” after many years of hard work and good investment decisions, we have managed to achieve a sense of financial security. Some of our investment decisions were sheer luck—being in the right place at the right time. However, there’s much truth to the adage, “Luck is what happens when preparation meets opportunity.” Any financial planner worth her salt will tell you that financial planning and investing work best with a long-term horizon.Real Estate as an Investment Traditionally, real estate has been the investment of choice, especially for middle-class families. The family home usually represents the single biggest asset and largest purchase most people will make in their lifetime. It provides shelter while appreciating in market value, and in some cases it provides rental income as well. During the past few decades, real estate has posted impressive gains while experiencing less volatility than the stock market. Increasing home values have allowed many homeowners with sufficient equity to finance other purchases, such as home improvements, cars, vacations, and various other large-ticket items. Rising prices have been offset the past several years by easy credit, which has allowed many people to become homeowners with little or no down payment. Recent newspaper headlines indicate that the easy money once available to homebuyers is coming to an end. A rise in defaults of subprime mortgages, which provided credit to borrowers with lower incomes or poor credit histories, began this current crisis. These mortgages were packaged into collateralized debt obligations (CDO) that created an even bigger supply of funds for lending. The CDOs provided financing for mortgages, and the cash flow from homeowners’ monthly payments was used to pay investors. This worked well as long as the payments kept coming. The risk factor became all too real, however, when significant numbers of loans went into default, and CDO investors began withdrawing from the market. With less money available, credit standards have tightened and fewer buyers qualify for loans. The supply of houses for sale is growing and the prices are dropping. Borrowing against home values has become more difficult as well, thereby causing a decrease in consumer spending. Needless to say, this downturn in the housing market has caused more than a few ripples in the broader economy. On a positive note, in a society that has grown accustomed to immediate gratification, the drying up of easy credit should remind us all of the virtue of sustained financial discipline. Major expenditures, such as a new car or that much-needed vacation, are infinitely more gratifying without the lingering shadow of debt (plus interest) to repay long after the glow of the initial purchase is gone. Use Common Sense Despite the recent downturn in the real estate market, homeownership is still one of the best long-term investments around. Building financial security doesn’t need to be a matter of luck if you use common sense and make financially prudent choices. Establish a personal budget and include an amount for savings. Being aware of your expenses can help control spending leaks. Once you have a budget, stick to it. Consider a 15-year mortgage instead of a 30-year mortgage. Over the course of a 30-year loan, a homeowner spends approximately 1 Qs times the purchase price of the home on interest expense. Pay off high-interest debt. If you’re paying interest on credit cards and installment debt, you’re paying a lot more than retail price for your purchases. If you can’t afford to pay off the balance at the end of each month, you are probably spending too much. Maximize employee benefits. Contributing to a retirement plan and making the most of flexible spending accounts and health insurance coverage are efficient ways to save money by reducing taxes and out-of-pocket expenses. Except under a narrow set of circumstances, resist the temptation to raid the 401(k) before retirement! I encourage you to share your own ideas with our readers.
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