Recently I’ve been engaged in a debate with a reverse mortgage advocate on whether reverse mortgages are a great way to provide money for retirement or an expensive loan that takes hard-earned equity from old people. You can see the comments here, in Reverse-Mortgages: Run Away Dont Walk. I doubt we’ll ever get agreement on the best approach, but the best result from a purely mathematical basis comes from when you downsize your home and then use the equity you free up to create a retirement portfolio. In that case you are receiving interest. In the case of the reverse mortgage you are paying interest, and a lot more interest than you would pay to purchase the home with a conventional mortgage for reasons I go into in the comments. You might want to do the reverse mortgage if it is your only choice and you absolutely cannot downsize to another home, but the higher price you pay is the cost of the choice you make.
But the real sad thing is the scenario presented where you have a couple that has to tap the equity in their home to pay for expenses. People shouldn’t be in the position in their retirement years where they need to start using the equity in the home they’ve worked so hard to pay off to cover retirement expenses. I see nothing wrong with selling a big home and freeing up the equity because you want to use the money for other things, but it is different when that and Social Security is all you have (and don’t count on Social Security – it’s not a good plan with the country looking at $20T in debt in the next couple of years).
I’d like to see my readers being smart with money starting from a young age, such that you are a decamillionaire or even a centamillionaire by the time you retire so that you have plenty of money to live on. Not only would that provide a lot more security and ensure no worries about running out of money, but it would allow you to take more risks and increase your retirement income. So the question arises, where should you be to get there? Here are some ways to tell where you are financially, going from the bottom to the top.
In deep trouble, in risk of bankruptcy: Obviously if you have a huge amount of debt you are near bankruptcy, but what are the early signs? If you have credit card debt and find that the balances are growing each year, you are slipping into serious financial trouble. Even if you are finding that you need to use the cards to float bills for a few weeks each month, you are just one emergency away from getting into a hole from which you’ll find it hard to get out. If you are in this situation, the first step is to gain some extra income from an extra job so you can pay down some debt and create a positive cashflow where your income exceeds your expenses each month. Then, budget and work to keep paying down your debt until you become debt free. The bigger the hole the slower will be the start, but keep working and eventually you’ll get onto firm ground.
Debt free, no credit cards, but no savings: This is a better place to be than to be using credit cards, payday loans, and the like, but if all of your money is going out the door each month and you don’t have any money set aside for emergencies, you could easily see yourself in a situation like a car accident or even a car repair where you could take on some debt that will push you over the edge. Here you need to gain some income or cut some lifestyle for a period to build up an emergency fund of about $10,000-$15,000. This is cash that will be there to pay for any curve balls that come your way and keep you out of debt.
Some cash in the bank, but no investments. You are better off than probably 75% of Americans, but you will have trouble in retirement and have trouble paying for your kid’s college. Try to cut back lifestyle enough to put 10-15% into retirement like a 401k or an IRA and start an educational IRA or 529 plan for your children’s college costs. You’ll need the money sooner than you think. One plan is to direct more to retirement with each bonus or raise so that you won’t miss the money. Also see if you are paying too much for your home – payments of no more than 25% of your take-home pay is an amount that will allow most people some freedom to invest.
You have an emergency fund and fully funded retirement and college accounts, but no other investments. This is fantastic. You’re doing better than a large majority of Americans, but you’ll not be financially independent until retirement. For that to happen, you’ll need to invest in a taxable account you can access for expenses before retirement age. See if you can free up some money each month for investing, even if it is only a few hundred dollars. It may start small, but you’ll be surprised at how far you go in 10 or 20 years.
You have a net worth of your age x your salary/10 or more: This is the definition from The Millionaire Next Door for individuals who are likely to become wealthy in their lifetimes. This puts you in a very select group of individuals. Keep it up from the time you are in your mid twenties and you’ll not need to worry about money by the time you reach your mid-forties.
How are you doing with money? Are you winning? Can you do better? I’d love to hear your story.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.