How to Play Debt
but the mortgage...
by Al Levit
Glendale, CA (Aug. 13, 1998) -- Today and tomorrow, I want to return to one of the basic questions that lies at the heart of Cash-King investing. As explained in Steps 2 and 3 of our 11 Steps, first and foremost a Cash-King investor should have his own personal finances in order before he begins to make Cash-King investments. Today, I'll look at balance sheets, and tomorrow I'll explore in greater detail what we Cash-King managers call Your Personal Flow Ratio (YPFR) -- lookie there, an acronym!
As far as my own personal balance sheet is concerned, I try to hold myself to the same high standards that I demand for the Cash-King companies that I find worthy of my investment dollars. How do I do this? The answers all revolve around the subject of interest. And the questions are:
1. Do I know how much interest I'm paying -- on everything from credit-cards to car payments to mortgage payments? If I don't have a good grasp of interest rates and my total interest payments per month, then I'm not ready to begin investing.
2. Am I paying any interest that isn't deductible against my taxes? If I am, then I have an excellent RISK-FREE investment alternative available. I can take money that I would otherwise invest and use it to pay off this non-deductible debt. Some people have suggested to me that I should take this money and use it to buy stocks (oddly enough, these are usually full-service brokerage reps). That's not for me. This Fool would rather eliminate the non-deductible debt first, and only invest once it's gone.
3. What about if the interest on the debt is tax deductible? That's a different story. There are plenty of times when it makes perfect sense to invest in stocks while paying deductible interest (at least I hope so, since I am actively engaging in the practice!) Like most good things, however, there are limits, so let's explore those limits.
For most of us, there are only two ways that interest can be deductible. Either you can borrow against stocks on margin, or you can borrow against your 1st or 2nd house. Some Fools have no problem with using a limited amount of margin off their investment account, but that one doesn't work for me. I find it inconsistent with the Cash-King philosophy -- which says that patience and methodical savings will win out over exposing yourself to risk for accelerated returns. I can see how buying on margin could work at times, but it's not for me. In the same way that I like a company with no debt, I like a brokerage statement with no debt.
That leaves the mortgage.
As noted, my family pays a mortgage, and we invest in stocks, so I clearly believe that the practice is okay. Paying deductible interest while investing usually means you'll be playing against a real interest rate that you can beat in the stock market. Interest paid on home mortgages is typically lower than interest paid on almost any other kind of loan, further helping the comparison. Therefore, if you "pencil it out" (or these days, I guess you would "spreadsheet it out"), it almost always makes sense to pay down your mortgage as slowly as possible and invest the difference.
Yet, interestingly enough (bad pun), that's not the route I've taken. I've actually gone for a 15-year mortgage instead of a 30-year mortgage, knowing full well that basic mathematics should have me going the other way -- investing in stocks and delaying my mortgage payments as long as possible. Why would I do this? Here are a few of my reasons:
1. I'm 43 now, and we just bought a new house. I don't want to have to pay a mortgage when I'm retired, and I don't want to have to be working when I'm 73!
2. I really do save hundreds of thousands of dollars on interest with a
15-year mortgage. Of course, I probably forgo more than that in appreciation in Cash-King stocks, so this one doesn't really count. But I had to mention it to make myself feel good.
3. By going with a 15-year mortgage, I do save 25 basis points (0.25%) on my interest rate, and this one really does count. This doesn't sound like much, but it adds up over time. That's the principle of compounding at work -- over long periods of time, reducing interest rates can be as insanely great as increasing investment returns.
4. I find it hard enough to live within my means, and nowadays the watchword seems to be to live below your means. I find that a 15-year mortgage forces me to do this.
5. I don't like debt, my mortgage is my biggest debt (by far!), and anything that pays it off more quickly works for me.
6. One of the biggest financial mistakes that young investors make (yeah, I'm a young 43!) is to buy too much house. Even though mortgages are an acceptable form of debt for us, hey, they still represent debt. Going with a 15-year mortgage convinced me to buy a house within or slightly below my means. I think. We'll see!
That's it for today. Tomorrow I'll explain and explore the Personal Flow Ratio.
Stock Change Bid AXP -3 5/8 95.00 CHV - 1/16 79.81 CSCO -1 7/8 96.69 KO - 15/16 78.75 GPS -3 1/16 63.50 EK + 3/8 82.06 XON + 69/73 68.19 GM - 9/16 69.06 INTC - 3/8 85.25 MSFT -1 1/8 103.94 PFE + 3/16 102.00 TROW - 15/32 34.00
Day Month Year History C-K -1.27% -3.10% 11.99% 11.99% S&P: -0.86% -4.08% 7.35% 7.35% NASDAQ: -1.26% -3.73% 9.05% 9.05% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 103.94 32.80% 5/1/98 37 Gap Inc. 51.09 63.50 24.29% 2/3/98 22 Pfizer 82.30 102.00 23.94% 2/27/98 27 Coca-Cola 69.11 78.75 13.95% 6/23/98 23 Cisco Syst 86.35 96.69 11.98% 2/6/98 56 T. Rowe Pr 33.67 34.00 0.97% 2/13/98 22 Intel 84.67 85.25 0.68% 5/26/98 18 American E 104.07 95.00 -8.71% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 82.06 29.95% 3/12/98 20 Exxon 64.34 68.19 5.99% 3/12/98 15 Chevron 83.34 79.81 -4.24% 3/12/98 17 General Mo 72.41 69.06 -4.62% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 24 Microsoft 1878.45 2494.50 $616.05 5/1/98 37 Gap Inc. 1890.33 2349.50 $459.17 2/3/98 22 Pfizer 1810.58 2244.00 $433.42 2/27/98 27 Coca-Cola 1865.89 2126.25 $260.36 6/23/98 23 Cisco Syst 1985.95 2223.81 $237.86 2/6/98 56 T. Rowe Pr 1885.70 1904.00 $18.30 2/13/98 22 Intel 1862.83 1875.50 $12.67 5/26/98 18 American E 1873.20 1710.00 -$163.20 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1641.25 $378.30 3/12/98 20 Exxon 1286.70 1363.75 $77.05 3/12/98 15 Chevron 1250.14 1197.19 -$52.95 3/12/98 17 General Mo 1230.89 1174.06 -$56.83 CASH $94.76 TOTAL $22398.57 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio for future investment. This will be reflected
in the numbers as soon as possible.
*The year for the S&P and Nasdaq will be as of 02/03/98
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