Continuing our series of occasional columns by Central Kentucky business experts, John Perry, an assistant professor of economics at Centre College in Danville, will be answering your personal finance questions, akin to nationally syndicated personalities like Dave Ramsey and Bruce Williams.
Perry's columns will appear monthly.
To submit a question, e-mail firstname.lastname@example.org; write "John Perry personal finance advice" in the subject line. Your name will not be published.
Not all questions can be answered, and those selected for inclusion in the column will not be notified in advance. Perry's advice is based on his business knowledge and is not a substitute for an in-depth consultation with a certified financial planner.
Question: I'm in the market for a house and have substantial savings. The home I'm looking at will probably run between $160,000 and $180,000.
I can't decide whether it would be better for me to use a modest down payment of $25,000 to $30,000, take out a 30-year loan and invest the rest, or just use the majority of my savings to go ahead and have a small loan and invest the money I'll continue to earn.
A few years ago, I probably would have followed the first option in a heartbeat, expecting a better return on my money than my loan rate would have cost. But now I'm overly cautious given the market's volatility and steep losses last year. What would you suggest?
Answer: Before you view your savings as available, I would urge you to pay off any outstanding debt, such as credit card and auto loans, and to have an emergency fund of three to six months of living expenses in a savings account.
From there, the classic answer is to put down a minimum of 20 percent. This prevents you from having to pay private mortgage insurance, which is insurance you buy to protect the bank from the risk of you defaulting. In addition to the down payment, you will also need cash for closing costs, potentially an additional $4,000.
If you do put more than 20 percent down, you are guaranteed a "return" equal to your mortgage interest rate on that money and are closer to owning your home outright. If you expect your investments to provide returns greater than your mortgage interest rate and can live with the uncertainty, as the stock and bond markets carry no guarantees, putting 20 percent down on the home and investing the balance is for you. There is no single right answer.
An instructive way to think about the problem is to pretend you had a paid-off home right now. Would you take a mortgage against it to invest in the stock market? If the answer is yes, put the 20 percent down and go. If the answer is no, then put more down and get the home paid for as quickly as you can.
Q: How often should I look at rebalancing my portfolio? I'm primarily in mutual funds but have a small percentage, 15 percent, of my money in specific stocks and bonds.
I want to be a long-term investor, but I'm much more attuned to what things are doing now given that I lost a large percentage of my retirement savings last year.
I don't want to obsess every day, but I also don't want to be totally passive.
A: You indicate having 15 percent of your investments in individual stocks and bonds. I would strongly encourage you to rethink even that amount.
Few individual investors have the time or resources to manage such investments. That translates into the investor taking on unneeded risk. A diversified portfolio of well-managed, perhaps even indexed, mutual funds is a much better approach.
That said, how often should a portfolio be rebalanced? Once or twice a year is fine. If you have a well-developed, long-run investment strategy, rebalancing becomes a clerical process: just making sure no type of asset makes up more of your portfolio than you intended because of gains and losses through the year. More important is to annually review and update your overall investment strategy and goals.
Q: I have two children, one is age 5 and the other is 2. My husband and I live paycheck to paycheck, but we want to start a college savings account now for the kids. What kind of suggestions can you offer on how to make that a reality when things are so tight?
A: It is admirable that you are thinking about your children's future. While it sounds harsh, you should forget them at least temporarily. College is expensive, but your children will have many earning years to deal with any college debt.
You will not be so lucky when retirement comes. Before putting money away for college, you should be saving at least 10 percent of your income for retirement, have no debt, and have an emergency fund.
Admittedly, that does not make saving easier. What can help is a monthly budget. Every dollar that walks in your door needs to be spoken for and have a purpose. That alone will show you savings opportunities.
While there is no substitute for a budget, there are some "tricks" to create savings. One is to "split" any raises with yourself. If you get a 4 percent raise, save half of it, or 2 percent of your salary. Have it automatically deducted from your paycheck. You will not miss it because you never had it, and you are still getting a raise.
Another clever way to save for college is the free program Upromise, www.upromise.com. You link a shopper's card or credit/debit card to a Upromise account, and when you make purchases of certain products or at certain merchants, a percentage of the price is automatically deposited in your account.