The Time Value Of Money And Debt Management

Our clients ask us a lot about getting into retirement and how to pay for different things. Or a lot of times we just get a phone call that says, hey, I need to take out 30, 40, $50,000 from my account to,you know, to pay down my car or to buy a new car to replace my car. It’s getting old.

Or, you know, maybe I’ve got another 50,000 or 100,000 left on my mortgage and I want to pay that off. So I wanted to go through a couple of scenarios and give some, you know, some things to think about that we tell our clients. So, you know, the first thing that we try to educate people on is the time value of money.

So share with our audience exactly what is time value of money? Yes. The time value of money definition is just. The time is a financial concept that holds that the value of a dollar today is worth more than the value of a dollar in the future.

So this is actually true because of growing inflation. We know inflation now, it will lessen the value of what the dollar today will buy in the future. Yep.

Yep. So there’s also, with time value of money, there’s something real called opportunity cost. So whenever you use your cash up today to buy an asset, a car or a home, you don’t have those dollars growing for you in the future.

So that the opportunity cost is the difference between what you could make if you left that money invested. You know, let’s say that you can. The markets have.

Have averaged 12% over time. We’re not going to even figure on 12% because you, if you follow our strategy, you’re going to have a diversified strategy. You can have some fixed income and things like that.

So let’s just assume that you could get 8% now and you’re looking at buying a car, and you can either use up your dollars to pay for that car, and if you have to take it out of a retirement account, you gotto pay taxes on it and a penalty if you’re under 59 and a half. Or you could finance that car maybe at, say, 6%. Well, the difference between what you would pay in interest, the 6% and the 8% that youcould potentially earn, is your opportunity cost.

So not only are you giving up some dollars, but, you know, you’re given up the opportunity that to get the earnings that that money would reap for you if it stayed or likely reap for you if it stayed invested. So this is true with homes, too. Jason, you want to go over some of the things that we talk about with our clients, when they consider withdrawing money from their portfolios to pay off their homes.

Absolutely. So with the home specifically, we get these questions from clients that are just asking, hey, I’d like to just pay off my home a little bit earlier than expected. We just want to remove all of our debt.

That’s wonderful. That that’s the mindset, you know, the fear of money and, you know, owing. You know, the Bible talks a lot about that.

But with us, when we look at the retirement assets, we do have to factor in the taxes with the qualified accounts. So that’s something built in there that we have to be sensitive to. But also, at the same time, if the assets are actually helping them make, if they’re taking income from these assets, if they’re able to make the mortgage comfortably with their other fixed, uh, you know, Social Security or pension or other the income sources that they might have, then why remove that block of money when that can be working for them? Because once you remove that block of money, um, you have lesser total account value that can work for you for the future because, um, expenses are only going to go up because of inflation.

The same expenses you pay now, in 30 years, you’re going to be paying those same expenses even if you remove all the debt. So that’s really how we like to breakdown retirement. Lifestyle is to your income, meeting your expenses.

And what can you change when you’re not working anymore? Only your expenses to a point. So one of the things that I share a lot with clients is that if you have the money to pay off your loan, you’re not technically in debt, right? You’re using somebody else’s money and, you know, to, for a very practical reason, to put a roof over your head, you know? And if you’re, if you’ve got those golden handcuffs and you’ve got a loan that’s in the twos or the threes or even the 4% range, the opportunity cost, as we just talked about, is a lot greater to take that money out, especially if you’ve got to paythe taxes on it, and then you’ve got, you know, other things to be concerned about. If you’re close to that 65 age where you could get Medicare because they’re looking at your income for Aunt Irma,right.

The tax, the extra extra that you have to pay on Medicare premiums if your income goes over a certain amount. So that can, that can impact you for a whole year. Well, what if you’re younger? You know,what do we, what is this some advice that you’d have for some younger people, younger people, it’s in my case, first time home buyers, we’ll start with those and then we’ll work into the car conversation.

Really, to us young people that don’t have assets or they’re growing assets or accumulation, we’re in the accumulation years is how we like to use those. I’m 37. So if you’re looking at first time home buyers, we’re really left with one option, and that is not to pay attention to the interest rates or timing of the market.

Obviously, it’s looking at can you afford the mortgage after property taxes, homeowners association fees, and then of course, you know, the actual interest rate that’s built into you paying this off, most likely looking at a 30 fixed, 30 year fixed. So what you have to do is look at saving. You have to save because really that cost once you move into that home is going to be an expense.

Luckily, it’s going to be fixed because if you’re renting, it might go up with inflation. That’s the part with the renting that my age group is kind of running into, for sure. But you have to save.

And how I like to look at it personally is, you know, that 20% down removes that private mortgage insurance. So you don’t want even more cost to what your monthly expense is going to be, because it’sreally just an expense. Same goes with a car.

You don’t have assets. So what’s that expense to you and your household? How much discretionary spending do you have afterwards? There’s that old saying that is, it’s not how much you make, buthow much you can save. You see, Bloomberg and these other media outlets talk about how people that are making will use the figure of six figures and they’re living paycheck to paycheck.

Now they’re probably talking about New York City and places that are very expensive. We know it’s usually specific to certain areas of the country, but you know, they’re not saving anything at all. So it doesn’t matter how much they make.

So as a young person, it’s really just how much you can save, not only just from retirement assets, but just even your emergency savings to protect you in the event of, hey, your AC goes out because you bought a really old home and it was overpriced comparatively to how much you keep, how much you end up with it at the end of the day is the real key there. So what would you say to a young person who wants to bypass that? The time it takes to save up for that down payment. And let’s say that they want to take it out of their 401K.

In regards to time value money, what would you tell them to think strongly about? I mean, if you’re looking at doing a loan, you’re going to have to pay that back. So that would have to be a just sort of a math cruncher there. So, but if you’re 59 and half, at least from that point, then you’re looking at taxes.

So if you’re a young person or you’re already 59 and a half, you want to take that out to buy the car. You’ve also got to factor in taxes around that point as well and then possibly a payback. So it really all,it depends on the situation of the person.

What about the young person who wants to take their 20% down payment for their home out of their 401K account? Still being a young person, you’ve got a penalty you have to deal with. So it would have to be about the net to put in there. I would, I would recommend it’d be best to work on the saving aspect after tax because everything’s going to be after tax for you.

And leave your retirement savings with the match, hopefully with your employer if that’s what you have to, the time value of money to grow because you’re going to need that later anyways because you might not stay in the home that you’re buying. It might not be your forever home. Yeah.

So there’s a lot of, lot of questions in that. Absolutely. Scenario.

And that time value of money is, is very crucial to the young person. If you take out that, that large chunk of money early on, I mean, you look at the time value of money going, you know, 20, 30, 40 years down the road. I did a quick calculation and, you know, just around $50,000 growing at 8% 20 years down the road is, you know, somewhere around 250,000, you know, so you look at that, that’s your opportunity cost for taking out that, that chunk of money, and then you’ve got to take out, you know, more than that if you’re going to, you know, cover the taxes, too.

So patience is a virtue here. When you say.

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