What's Better...Short Sales or Savings?
No, this isn't a trick question nor are we opposed to savings - in fact, liquidity is an essential survival strategy that helps investors at all levels ride out tough economic times; however, it is possible to take anything to the extreme including savings.
As Americans across the nation embrace savings for the first time in years, there is a growing need for rational financial reasoning especially when it comes to investments. For years consumers were content to spend money they had not earned then simply make credit card payments or take out a second mortgage. Today all that changed as the rate of savings has gone from literally less than zero to nearly ten percent within the past two years.
While paying down debt and getting one's financial house in order is always a good thing - it is not the same as investing. Setting aside money for a rainy day and keeping a little extra on hand for emergencies is also a solid strategy but should never be confused with growing your money.
Let's take an up-close and personal look at short sales versus savings to see how it will impact the average investor. We will use a hypothetical case study of Mr. Saver versus Mr. Short Sale to see how each strategy plays out over time.
Mr. Saver
Mr. Saver is like most average American's; he is fortunate enough to still be employed and has an "average" household income that just happens to reflect the nationwide median - $50,000. Mr. Saver is 30 years of age with 1.3 children (the third child is a very spoiled dog), married and wishes he had more time to spend with friends and family. Mr. Saver has another 35 years to work before qualifying for Social Security (actually 37 more years but who is counting) and puts away a whopping 10% of his income each and every year....which is far above the national average but we are going to use extremes to show the very real difference in expectations.
At the end of the year, Mr. Saver has put $5,000 into savings and plans to continue with this same habit for the next 30 years. Current interest rates are roughly 2 percent (if you are lucky). At the end of 30 years Mr. Saver will have a balance of $215,750 after managing to save $156,200. Sounds pretty good right? Well, not really. First of all you need to take inflation into account.
Using a historical 30 year adjustment, that same $215,750 will only be worth approximately $73,000 in today's dollars. Yes, we know that is less than what you paid in but that is how inflation works...it robs your money of value over time. To add insult to injury, Mr. Saver must pay taxes on the earned interest. Using a conservative estimate from today, that would eliminate at least another $10,000 to $12,000 leaving roughly $205,000 or less than $70,000 in inflation adjusted purchasing power. Wow...Mr. Saver worked hard and did without for 30 years just to set aside about 18 months of income. He better hope Social Security is in good shape by then because he is going to need it!
"Wait a Minute" you might argue, "Interest rates are likely to go up after the economy recovers". That is certainly true but by definition, interest rates typically lag behind inflation rates or the banks could not afford to lend money. Additionally, most people tend to save less when prices rise - remember, just a few years ago the national average for savings was literally below zero. However, for the sake of debate, we will use a historic interest average of 5 percent. At the end of 30 years the total balance would be just under $370,000 with the same $156,200 contribution and $212,000 interest earned. Taxes on interest would conservatively run $25,000 leaving a total of $345,000 or $116,000 equivalent adjusted for inflation. It's Better... but not by much.
Mr. Short Sale
Mr. Short Sale also is employed with a household income of $50,000, 1.3 children and no other debt. Instead of putting his money into a low interest savings account, Mr. Short Sale decides to invest the same $5,000 toward purchasing his first modest short sale home. He decides to rent it out and allow someone else to pay for the mortgage so is able to take hefty tax write-off's after combining the PITI plus depreciation and closing costs. For the sake of simplicity we will assume he rents the home for just enough money to allow the home to pay for itself without making any profit...in reality, it would be much more likely to create a positive cash flow.
Mr. Short Sale continues to purchase a home every 2 years rather than putting the money into a savings account. At the end of 30 years Mr. Short Sale own 15 homes each generating a steady income that pays for itself. One home is paid in full and every 2 years another mortgage is paid off adding to the total number of paid in full homes. Mr. Short Sale can either continue to collect rent every month or sell one or more properties to fund his retirement.
Because real estate is a tangible asset, it has continued to appreciate in value each and every year so those purchased early in his investment career are now worth substantially more in value. In fact, let's assume Mr. Short Sale purchased very modest starter homes for only $50,000 in 2009. In 30 years when he goes to retire, that same property should be worth at least $150,000 due to inflation....that represents only one year's savings compared to 10-15 years worth by Mr. Savings above. Remember, every two years Mr. Short Sales will have another mortgage paid in full.
Ask yourself, how "safe" are your savings compared to short sales?
See you on the other side!
Charles Gardner
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