To Buy or to Rent

Question of the week:I've been happily renting my place for years, but the low mortgage interest rates these days are starting to tempt me into buying. Do you think it's better to buy or to rent? --Lynne S.

Dear Lynne,

For many people, their home is not only their biggest investment; it's also a place of enormous emotional importance. So, your question needs to be considered beyond just the financial implications. When we posed your question to members of the Armchair Millionaire community, we heard many thoughtful responses that underscore how complicated the issue can be. Here are two examples from both sides of the fence:

Buy. "The only regret I have about home buying is that it took me so long to do it! Renting is just like throwing your money out the window. My mortgage payment is less than what I was paying in rent years ago. I want to have something to show for my hard work and a house is a great place to put your money. " --Danny

Rent. "I live in NYC and fortunately have a rent stabilized apartment. My rent is very low, my apartment is very nice. I can save and invest money and have enough left over for some goodies. I don't have to shovel snow, or cut grass, or repair plumbing. So, I don't get a tax break. I've done the math and I'm better off now. And I always know I can move, with very little notice to my landlord." --Mary

Obviously the best answer is going to depend entirely on your own situation. To help sort out all the factors to consider, I generally suggest that people look at the equation in two parts. The first takes your lifestyle into account. Is pride of ownership important to you? How would you feel about spending Saturday mornings mowing the lawn? Is the security of your own home important to you, or do you prefer the lack of ties that renting offers?

The second part of the equation looks at the finances of renting versus buying. This can be a little more complicated, so use my checklist to run down all the issues you should consider.

The Armchair Millionaire Checklist of Pros and Cons of Renting and Buying

• Equity. For renters: You won't get it. Once that rent money is gone, it's gone. For owners: Paying the principal amount of your mortgage each month is like "forced savings" and over time, you'll accumulate equity you can borrow from or convert to cash upon selling.

• Taxes. For renters: Sorry, your landlord will reap the tax breaks. For owners: Depending on whether you itemize, your tax savings can be significant.

• Interest costs. For renters: No worries here. For owners: You'll likely pay a huge amount of interest over the life of the mortgage-often much more than the amount of the loan itself.

• Investment value. For renters: You won't benefit from any increase in the value of the property you rent. For owners: It may go up or down, but given historical trends, you'll come out ahead.

• Flexibility. For renters: If you want out, just move when the lease is up. For owners: If you want out, you need to go through the time-consuming and expensive selling process. Given the costs of the transaction, you generally need to keep a home for a few years in order to avoid losing equity.

• Maintenance. For renters: Leaky pipe? The landlord is just a phone call away. For owners: Either you do the work yourself or pay someone else to do it.

• Monthly costs. For renters: These are fixed-aside from annual rent increases, you know what each month's outlay will be. For owners: Costs are variable, and there may be months when you have to shell out for repairs or maintenance.

THE BOTTOM LINE: Home ownership is called the American Dream because it is right for so many people, but that doesn't automatically mean it's right for you. Weigh the pros and cons carefully before taking the plunge.

Deciphering Life Insurance Lingo

Question of the week:With two young children, we know we need life insurance, but are a bit intimidated by all the choices. What's your opinion about the best type? --J. and P., San Diego Dear J and P., I find that there's a lot of confusion around all the options in life insurance, but that once you know the basics it will soon become clear which one is right for you. As you can see from these recent comments from members of the Armchair Millionaire community, these folks hold clear, strong opinions: "I have term life insurance. I think whole life insurance is a waste of money because you don't have control over where that money is being invested. Buy cheap term life insurance and invest your money elsewhere." --Tiffany "Our polices have investment components. Otherwise, it is pretty much just a waste of cash if you live to be a ripe old age!" --1 So what exactly are these people talking about? And how can they have such contrary opinions? To start, it's helpful to understand that there are two broad categories of life insurance: temporary (commonly called term), which lasts for only a set amount of time, and permanent (also called cash value), which lasts for your entire life. Another key difference is that term insurance simply pays a benefit if the insured person dies while the policy is in effect, while permanent insurance includes an investment component so that a portion of your premium is invested. This is where the major differences of opinion arise. The people who argue for term insurance (this includes me) generally believe that they can get a better return on their money by investing on their own, while fans of permanent life insurance believe the insurance/investment mix can be a valuable combination. Unfortunately, beyond these basic distinctions, it gets a little more complicated, and this is where some people get lost. To help you make an informed decision, my guide will help you decipher the lingo. The Armchair Millionaire Guide to Life Insurance Choices Term insurance. This is the cheapest, simplest kind of life insurance. Buy a policy for a set term (typically 10 or 20 years) and if you die during that time, your beneficiary will receive the benefit. Whole life. This is the simplest type of permanent life insurance. Your premiums remain the same throughout the life of the policy, and a portion of each premium is invested by the company, allowing you to accumulate this money (the cash value) on a tax-deferred basis. Universal life. This has the same basic features as whole life, but is a bit more flexible. If you choose, you can pay in amounts above your regular premium, and adjust the death benefit relative to the cash value amount. Variable life. With a variable policy, you get a choice of different funds where the company will invest your money for you. Generally, if the investments do well you'll have a higher death benefit and greater cash value. It they don't do well, you'll have a lower death benefit and cash value, though some policies guarantee a minimum death benefit. Variable universal life combines the flexibility of adjusting the amount of the death benefit and premium (as in universal life) with the ability to take a little more risk in investment choices in the hope of getting a bigger return (as in variable life). THE BOTTOM LINE: While complex at first glance, life insurance need not be overly confounding. If you understand your choices and are clear about why you're buying life insurance in the first place, the right option for you will be obvious.

Sidestepping the Investment Pitfalls

Question of the week:I've saved up a nice little amount and am ready to start investing it. However, I dread making a mistake with this hard-earned money. What are the common errors I should be on the lookout for? --Ann L.

Dear Ann,

You're absolutely right that sometimes what you don't do is just as important as what you do, and smart to be looking out in advance for the pitfalls you might encounter.

When we asked Armchair Millionaire community members about their investing regrets, we heard about everything from investing in time shares and mobile homes to investing too much (or too little) in technology stocks. Here is just a sample of the comments we received:

"My mistake was not understanding the concept of time value of money until I took a personal finance course in college at age 27. So I foolishly spent money made in my teens and twenties without saving or investing it, and started saving at 30 instead of 20." --Mike

"I trusted too much in the stock of the company that I worked for. I had the feeling that as long as I got good results, 'my' company would do well, and therefore only bought stock in this one company." --Maarten H.

"Before knowing better, I bought mutual funds with a load. Never again! The funds' performance wasn't that good, either." --Chris H-W.

So even thought the investing world may seem fraught with land mines just waiting for you to take the wrong step, it's really not that bad. With a bit of clear thinking about your choices, you'll do well. My guide will get you started.

The Armchair Millionaire Guide to Steering Clear of Investing Hazards

• Be informed. Read widely--there are a number of excellent, common sense investing books available. Talk to friends who've been successful with investing. If your employer offers educational programs about investing in your 401(k), take advantage of them. And it you feel you need professional advice (I recommend it if you have a complex financial situation), see a fee-only financial advisor.

• Be skeptical. If it sounds too good to be true, it probably is. Scams and schemes are fairly easy to spot, but you should cast a skeptical eye even on legitimate investments. Don't take everything you hear about an investment at face value. Just because a mutual fund has no load, for example, doesn't mean that it doesn't still have real costs. And the fact that a fund may have performed well last year has no bearing on how it might perform this year, or next.

• Go slow. Achieving your most important financial goals, like sending a child to college or funding an abundant retirement, happens over years. A small but regular monthly investment in your financial dreams will get you much further than any short cut ever will. The old cliché is correct: Slow and steady really does win the race.

• Don't hesitate to start. Don't be so worried about making a mistake that you fail to invest at all. If you wait until you're an expert to start, you may never even begin. The best way to learn is to start small and learn from your mistakes.

THE BOTTOM LINE: Investing is a lifelong journey and like everything else in life, wrong turns are unavoidable. But by thinking your decisions through carefully, you'll minimize those mistakes and put yourself on the right road.

What to Do with a Windfall

Question of the week:We've just received an unexpected windfall of $10,000. My wife says that we should invest it, but I want to pay down some debt. Which do you think is best? --Russell from Tampa

Dear Russell,

Yours is one of the classic dilemmas in personal finance. We posed your question to members of the Armchair Millionaire community. Some advocated paying down debt, others the investing route. And others, like this one, advised a little of both:

"I would break it down into four buckets of $2,500 each. I would pay some credit card debt, put $2,500 in my emergency fund, invest $2,500 in either individual stocks or a stock mutual fund and I would spend $2,500 on something fun for me." --Mattchiavo

Either way, you'll get a return on your investment. The question is which offers the best return. To run the numbers, you'll need to look at the interest rate on your debt and figure what you would save in interest, as well as assume an annual rate of return on the investment you might make. And you'll also have to figure in the impact of the taxes (if any) that you would have to pay on your investment returns.

Here's an example. Let's assume you're paying 15 percent annual interest on credit cards, and that it would take you another five years to pay them off with your current payments. By using your windfall to pay them off immediately, you'll save $4,274 in interest over the next five years. On the other hand, if you invest that money in a tax-deductible account and receive an average annual return of eight percent over the same five years, you'd earn $4,898. Keep that investment over the next 20 years, however, and you'd earn $39,268.

However, the numbers don't tell the entire story. The best alternative will depend entirely on your own situation. My guide will help you make the right choice.

The Armchair Millionaire Guide to Choosing Debt Reduction or Investing

• What kind of debt is it? Some kinds of debt are better than others. A mortgage, for example, is a far cry from high-interest credit card debt. The interest rate is lower, the interest may be tax deductible, and that debt allowed you to buy an asset that's likely to increase in value over the years. On the other hand, credit cards have high, non-deductible interest and are often used for one-time purchases, like dinner out or a tank of gas--things that are gone long before we even pay for them.

• Do you have a plan for avoiding future debt? If you pay down your debt but then immediately run up your credit cards again or take out a new loan, you'll have gained little for the long term and will have lost a great opportunity to invest.

• Do you have a good place to invest the money? If the stock market doesn't look attractive to you right now and your investing alternatives are a low-yielding money market fund or CD, you're probably better off paying off the debt. But if an investment in the stock market looks good to you, this could be the better route.

• Can you make the money go even further by investing it? If you can tuck your extra money away in a 401(k) or tax-deductible IRA over the next couple of years, you'll enjoy a nice tax break in addition to your investment returns. You'll do even better if you employer matches some portion of your 401(k) contribution.

THE BOTTOM LINE: Financial windfalls are as rare as blue moons, so act carefully. Take time to weigh your options and arrive at the one that will have the best impact on your long-term financial health.

Slaying the Plastic Monster

Question of the week:I've really gotten in over my head with credit card debt, and it is beginning to seriously worry me. What's your strategy for paying off credit card debt once and for all? --E.D.

Dear E.D.,

While it can be discouraging to face a mountain of credit card debt, it's important to remember that there is a way out. We heard many success stories when we asked members of the Armchair Millionaire community about their experiences in cutting their debt down to size. This one is typical:

"My wife and I got ourselves into a substantial amount of credit card debt over the past five years. It all started back in college, but snowballed out of control when we got married, went on a honeymoon and a cruise and bought a house. We learned our lesson and now have just one credit card for emergencies. So far, we have not touched a credit card in six months and are on our way to being debt free." --N.W.

The key is to systematically confront your credit card debt with sound tactics designed to accelerate your repayments and reduce the overall interest you pay. My checklist has the essential moves.

The Armchair Millionaire Checklist for Digging Out of Credit Card Debt

• Stop charging! If you can't afford to buy something without using a credit card, do without. While this may feel a bit painful at first, many people find that the things they've been buying with credit are things they really don't need.
• Double (or triple or quadruple) your payments on the credit card with the highest interest. This card is costing you the most, so concentrate on paying it off first. Once it's taken care of, move on to the card with the next-highest interest.
• Use your "extra" money. Whenever you receive "extra" income--like a tax refund, gift, or raise--commit it to credit card repayment. Since you hadn't planned on this income, you won't miss it, and those extra payments can make a big difference.
• Dig into savings. If you have some money stashed away in a low interest account (like a savings account), think about using it to pay down some debt. Your savings account is only paying you one or two percent interest, but you're paying much more than that on your debt.
• Consider finding an extra source of income. A second job doesn't have to be a huge time burden--even a few hours each weekend will earn you a nice chunk of money each month that will go a long way towards speeding up your debt repayment.
• Keep going. By the time you've paid off your credit card debt, you'll have developed a great set of money management skills. Put them to work on an investing program that will put your money to work to fund your long-term dreams.

THE BOTTOM LINE: Besides making you feel awful, debt is your main barrier to building a financially secure future. But by using some common sense techniques, you can push that monkey off your back.