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There is a good chance you, or a close family member, carry debt. It’s common for the typical American household to carry amounts exceeding six figures (Tsoie & Issa, 2018). Debt can be mysterious in the sense that individuals might owe a similar amount, but perspectives on how to repay debt vary dramatically. Debt is also not always negative and can provide strategic benefits in your financial plan. Consider a home mortgage for example, the underlying asset is likely to increase in value. Mortgages often offer a valuable source of leverage, but loans on depreciating assets like cars can quickly end up with negative equity. Other loans, like high interest credit card debt, can be especially menacing. This article will focus on consumer debt repayment and we will highlight a few common approaches to help the borrowers make real progress on eliminating debt.
Many households across the country have debt related to auto loans, credit cards and even personal loans. The decision to take on debt is personal and the need or desire for debt means different things to just about everyone. Below are some common questions to consider when developing a debt repayment plan.
One strategy that many people find effective for debt elimination is using rolling payments. Rolling payments involves focusing on aggressively paying off one loan at a time, while making the minimum payments on other debt. With rolling payments, you throw as many excess dollars in your budget as possible toward repaying one loan. Once the target loan is paid off, roll that loan payment into paying off the next debt beyond the monthly minimums. Keep rolling your payments to the next loan on your list until the ball and chain of your bad debt is paid in full. To illustrate a couple different ways to prioritize your debt list, we are going to look at three approaches for prioritizing debt, including, an interest rate approach, a behavioral approach and a combination strategy that factors in retirement savings.
When evaluating debt repayment from an interest rate approach, order all debts from highest interest to lowest, and attack the highest rate first. Focusing on interest rates makes sense because you are reducing the debt with the highest interest rate drag. Although progressive, the downside to this approach is that it might take months or even years until you finally check a loan off your list. Many people become worn out and lose motivation to follow the plan. There will also be cases where a loan with a lower interest rate, but larger balance will be more impactful on the overall repayment plan than a small loan with a higher rate. However, prioritizing debt strictly by interest rates ignores that.
Let’s meet Steve, who has three outstanding debts. Steve has student loans totaling $22,000 at 6%, a car note of $15,000 at 3.5% and $8,000 of credit card debt at 17% annual interest. Utilizing the interest rate approach, Steve will prioritize his debts according to the table below and use the rolling payment method, we discussed for repayment.
Now let’s consider Steve’s situation from the behavioral approach. This behavioral method prioritizes starting with the smallest loan regardless of interest rates. Compared to the interest rate approach, you will likely end up paying more interest overall with the behavioral strategy, but the small wins along the way provide motivation and reason to celebrate. This method has been popularized by the personal finance personality, Dave Ramsey, who consistently recommends focusing on behavior. He refers to this approach as the “debt snowball”. You can still take advantage of rolling payments with the behavioral strategy, so once each loan is paid off, roll the payment to the next debt on the list.
The power of compounding interest reveals its best to contribute early and often towards retirement savings for maximum growth. If your debt is not too overwhelming, it can be valuable to continue retirement savings while paying down loans. With this in mind, we can utilize a combination approach that addresses both debt reduction and retirement savings. One method is to target either a specific debt reduction or savings goal. Use your primary goal as a minimum benchmark then throw as many extra dollars in the other direction (debt or savings) as possible. Combining goals of retirement savings and debt elimination is best utilized when loan interest is less than the expected return of investments for retirement. Focusing on both savings and paying off debt can be helpful for identifying opportunities to “beat the spread” by investing versus paying off debt.
No matter how you decide to repay debt, take comfort in knowing the best strategy is one you can commit to and stick with during tough times. Here at Merriman, we believe in the power of committing to a sound plan for guidance throughout your financial life. If you’re lost on where to start, please take a few minutes to read First Things First by Geoff Curran, which provides a guide toward prioritizing your savings. If you have questions or would like to learn a bit more, please contact a Merriman advisor who can help navigate your specific situation.
Tsosie, C., & Issa E.E. (2018, December 10). 2018 American Household Credit Card Debt Study. Retrieved from https://www.nerdwallet.com/blog/average-credit-card-debt-household/
“Past performance is no guarantee of future results” is a required compliance disclosure used by money managers when reporting performance. Unfortunately, it is truer in the world of investments than almost anywhere else. When you find a 4.5-star restaurant on Yelp, there is a high probability that you will have a positive experience. Statistically, funds that had the best performance over the past three years (or one year) are no more likely to outperform the following three years than any other fund.
The same is true at the portfolio level. In the late 1990s, U.S. growth stocks were the best performing asset class and investors flocked to the S&P 500. We introduced the Merriman MarketWise All-Equity Portfolio in 1995 in the middle of this period. After the first five years, the cumulative return of the Vanguard 500 Index Fund was more than 2.5 times that of MarketWise, as Figure 1 shows. What happened over the next decade from 2000 through 2009? The exact opposite.
Over the tumultuous decade from 2000 to 2009, the MarketWise All-Equity Portfolio (after fees) was up 70% compared to the Vanguard 500 Index fund which had lost -10%, as Figure 2 shows. That 10-year period during which the S&P 500, cumulatively lost money is commonly referred to as the lost decade. It was a painful period for many investors. Their faith in the S&P 500 had been strengthened by nine straight years of positive returns (six years exceeded 20%) and by watching it outperform major indices around the globe.
While it was a difficult period, the investors who suffered most were those who switched investments based on past performance. Figure 3 starkly illustrates the effect of “chasing” good recent performance. The blue and orange lines show the cumulative returns of the MarketWise All Equity Portfolio and the Vanguard 500 Fund. The gray line shows the cumulative growth of funds invested in the MarketWise All-Equity Portfolio from the 1995 inception through 1999 and then in the Vanguard 500 fund from 2000 through 2009. While after fees, the MarketWise All-Equity Portfolio slightly outperformed the Vanguard 500 Fund, investing in either approach yielded solid growth. The investor who switched from MarketWise to the Vanguard 500 Fund at the top of 1999 ended up with less investment growth than the investor who stuck with either strategy throughout the whole period.
2009 to 2017 the S&P 500 again delivered nine straight years of positive returns and outperformed most major world indices. In 2018, the index was down -6.6% but has quickly rebounded in 2019. No one knows what the next ten years will bring. History suggests that past performance is no guarantee of future results and that tides turn, but when that will happen is anybody’s guess.
IMPORTANT DISCLOSURES: The performance results shown are for the Merriman-managed MarketWise All Equity (100%) Portfolio and the nonmanaged Vanguard 500 Fund, during the corresponding time periods. The performance results for the MarketWise All Equity Portfolio do not reflect the reinvestment of dividends or other earnings, but are net of applicable transaction and custodial charges, investment management fees and the separate fees assessed directly by each unaffiliated mutual fund holding in the portfolios. The performance results do not reflect the impact of taxes. Past performance is not indicative of future results. No investor should assume that future performance will be profitable, or equal either the previous reflected Merriman performance or the Vanguard 500 Fund’s performance displayed. The S&P 500 is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S. stock market. The Vanguard 500 Fund is a core equity index fund that offers investment exposure to the companies represented by the S&P 500 index. Source of VFINX data is Morningstar.
Written by: Geoff Curran, CPA/ABV, CFA, CFP® and Alex Golubev, CFA
The last few years have seen tremendous growth in the short-term rental housing economy. Services like Airbnb and VRBO connect homeowners and travelers around the world. While vacation rentals aren’t anything new, home-sharing platforms make it more convenient than ever for homeowners to earn extra money on their personal residence or vacation home. Airbnb fosters accountability and transparency by inviting hosts and guests to review and rate each other on criteria like cleanliness, following house rules, and ease of communication. A whole ecosystem of services has also sprung up to streamline and improve host operations (Smartbnb, AirDNA, NoiseAware, Vacasa, Evolve and many more). However, vacation rental remains a highly competitive and regulated industry.
Hosts in the Airbnb space face many challenges for success. Setting up homes for vacation rental, optimizing rental rates and cleaning properties between guests eats into time and money. Once rentals are rolling, even successful properties can hit speed bumps. Tourist demand is often seasonal or focused on appealing properties in central locations. Low barriers to entry can also reduce profits as more hosts enter the market and/or authorities create regulations to raise the bar. Short-term rental earnings have curbed in highly-regulated tourist hubs like New York, LA, San Fran, Barcelona, Berlin, and Amsterdam.
Given the popularity and potential of Airbnb, clients have started asking whether it makes sense to rent out their homes. We always encourage our clients to consider how renting their property will affect their life. If renting out your home helps you support your lifestyle and travel more, then exploring AirBnB could be an exciting opportunity.
AirDNA is a great starting point for researching vacation rentals in your area. AirDNA can help you assess the earnings potential of your home, whether you’d like to rent out your entire place or just share a room. Dipping a toe in the water of home-sharing during your next trip out of town is a great way to start!
The checklist below provides helpful points to consider before renting out your property:
Home Insurance: Check with your home insurance provider to ensure that your insurance coverage is still adequate and will remain in force if your home is rented out. The strategy of doing nothing and asking for forgiveness later just won’t work with insurance companies if you have a claim. We reached out to Sue Greer from Propel Insurance for her perspective on managing liability. She emphasized watching out for “contract language that can limit, or void, coverage entirely when the property’s occupancy is other than what was noted on the signed application.” It’s also important to ensure that your other liability coverage like umbrella insurance will still cover any accidents that may happen on your property if it’s rented out.
Security: It’s important to make sure that your home is secure and that any irreplaceable valuables are properly locked up when others are in your home.
If you have questions about this checklist or any other parts of your financial life, we recommend reaching out to a Merriman advisor. We can help with the decision to rent your home and with managing all the moving parts. You’ll have to share all the adventures you’ll be able to take once you explore Airbnb!
Young professionals juggle ramping up their careers, paying off debt, starting retirement nest eggs, buying homes and potentially building families. There is no shortage of goals for funneling your hard-earned dollars, and we can’t forget to have some fun along the way. It’s time to figure out how to take finances to the next level by supercharging savings and intelligently managing debt, so what do we tackle first?
Many years ago, as a sophomore in high school, I was preparing for my first AP exam. My friends and I looked over our notes, read through old tests and took note of the topics we weren’t as confident about. But we soon realized that there were topics not found in our notes or on past tests that we might be expected to address on the real exam. Those topics were where our biggest test-day vulnerabilities were hidden. Luckily, we had a teacher to help us identify and fill the gaps in our knowledge.
This type of blind spot exists in many areas of life, with varying consequences. Your financial situation probably includes at least a few holes you’re not aware of. Many of us end up on autopilot, thinking that because we set up our homeowner’s insurance when we bought our homes, or regularly save money, that we’re on top of things. But do we have the right amount of coverage for our home? Are we saving enough to meet our long-term goals, like retirement, and our shorter-term goals, like a special vacation or a new car?
Imagine your home is underinsured and a strong storm causes significant damage. You might be responsible for a sizeable portion of the repair bill if your coverage isn’t high enough. Similarly, many people who own investment rental properties don’t realize they’re underinsured for the potential liability they’re taking on.
Choosing a health insurance plan that isn’t optimal for you and your family can also lead to larger expenses in the long run. Do you have small children who go to the doctor often? Are you a healthy young adult who rarely needs care? Are you retiring early and not yet eligible for Medicare? The right health insurance policy is crucial to getting the care you need at the right price.
Those are just a few of the blind spots you might have and failing to address them might lead to a drastic change to your future plans. Your blind spots are unique to you, and they’re called blind spots for a reason; they’re hard to see! Just like all those topics on my AP exam that I needed my teacher to help me find and address, the best way to find the blind spots in your financial life is to get professional help. Here at Merriman, we’re skilled at finding your blind spots and, with the help of expert professionals like estate planning attorneys, CPAs, and insurance specialists, helping you fix them for good.
This year, we want to help you find and fix your blind spots. Start by taking our short quiz that can help you see the gaps. Then contact us and we’ll get to work helping you shore up your financial situation.
More than likely you or a close family member have faced a decision to lease or buy. Whether you’re interested in acquiring a new car, a home or a child’s athletic gear, your choice to lease or buy is likely influenced by what you learned growing up or by discussions around the office water cooler. Why does it feel like it’s such a tough decision? (more…)