invest in what you know

Imagine you have $500,000 in cash and a mortgage of $400,000 – and no other debt of any sort. Your mortgage is at a low rate and fixed for 30 years. Should you pay it off? This subject is debated endlessly – whether paying off your mortgage early is a good “investment,” since tying up your money by paying off your mortgage keeps it out of the mythical guaranteed-over-20-years 10% return in the market. Fine, you can use whatever assumptions let you sleep at night.
But let’s take that to another level. If you have $30,000 and want to buy a car, and the dealer offers you a ridiculously low rate – say 2% or less – on financing, should you pay cash or finance? And let’s take that another step further – why wouldn’t you use a home equity loan at a low rate to fund your home improvements, or even buying a car while letting your money work in the market?

Creative Commons License photo credit: freeparking

Asking this question is not idle speculation. We DID recently pay cash for a new minivan – we have aggressively managed our cash and savings to put ourselves in a position where we can pay cash for everything. We have no desire to pay off our mortgage early since (a) we plan to move at some point and (b) we have a good rate. But should we have financed the minivan? Was locking up a large sum of cash like that a bad idea? I know it’s a depreciating asset that loses 50% of its value the second we drive it off the lot, yada yada. Our cash is now gone – flown out the door. On the other hand, we can look at our car and say that it’s done and paid for, which is a nice feeling.

I think a person’s attitude towards debt has something to do with the types of investments they’ll make and their risk tolerance. I’ve said before that my family’s beliefs about debt were hard-core fundamentalist: debt was pure evil. Even mortgages were necessary evils. Investing is done with cash in hand; real estate investing is foolish because you can’t play the game without using other people’s money.

I’ve come to realize that one of my greatest weaknesses in terms of wealthbuilding is lack of focus. Bear with me here. I talk with people who invest in real estate and they have a relaxed attitude towards taking out huge debt on investments. They’ve done their homework, studied the market, etc. – and then gotten a mortgage from the bank and bought. This is not something I think I could ever do; yet at the same time I have spent a lot of time trying to educate myself about real estate investing. There is no point. If I am going to continue to build wealth it has to be in ways that I am comfortable with because the necessary focus and discipline aren’t there, otherwise. I hate debt, and investing in real estate requires debt. On the other hand, I have no problem with investing in individual stocks – because I have a deep understanding of financial statements and the operations of public corporations from my experience in auditing. So why don’t I stick with worrying about strengthening my knowledge in the area I understand and appreciate, rather than the one that gives me the heebie-jeebies?

So I sit back and decide that having a unifying principle – like paying cash for EVERYTHING – not only helps me sleep better at night, it makes sense within my realm of understanding and expertise. Liquidity is not my goal: a lack of debt and investments that generate cash flow are. I’m going to stick to investing in what I know, and try to forget about areas that I don’t care for and I don’t understand that well, like real estate. I think I will get rich sooner doing that.