Q. I am considering buying a house right now. I expect to be in the area for 4 or 5 years, and I'm trying to understand what the financial advantages are of home ownership. Appreciation I understand. I pocket the difference between purchase and sales prices. Equity-building understand. Not all the money I pay for rent goes into someone else's pocket; I keep some of it.
Tax benefits I don't understand. You say that tax benefits are "quite small." If I pay $12,000 for the first year of the mortgage and say $3000 for the first year's taxes, then I have $15,000 in deductions. Since I will itemize deductions anyway, I will make use of the full amount, which translates to nearly $5,000 in unpaid taxes. Granted, I've still paid a net $10,000, but it seems to me that the tax benefits are nevertheless significant. What am I missing?
---D.P., Dallas, TX
A. Nothing. For the details on home ownership deductions, go to my web site(
www.scottburns.com) and find my column from 3/03/96 which shows the net tax benefits at a variety of price levels, assuming a 20 percent down payment and no other tax deductions. My argument has regularly been that the combination of the standard deduction and
average house prices means the benefit is very small for
most people.
Most people, however, is not the same as
all people.
You can have significant tax benefits if you buy a relatively expensive house such as a $250,000 house instead of a $125,000 house. Similarly, IF you already have itemized deductions that take you over the standard deduction threshold, then you can view the additional deductions from home ownership as real tax bill cutters. If you are in this position, then the tax benefits from ownership may be substantial.
Deductions have been so tightened since the 1986 tax reform that relatively few taxpayers itemize--- even single taxpayers seldom have more than $4,000 in deductions outside of those from home ownership and very few people filing joint returns have non home ownership deductions exceeding $6,700 a year.
Q. We accumulated our investments by years of monthly investing, using the principle of Dollar Cost Averaging. It seemed to work very well. We invested mostly in stock mutual funds. Now that we are retired we are wondering, is that an effective way of disbursing our investments to obtain our living expenses?
--- R.H., Dallas
A. No, but you may not have a choice. Dollar cost averaging in reverse means you will redeem more shares when prices are down and fewer shares when prices are up. The net effect will be to worsen the impact of declines.
What you need to do is arrange your finances to minimize withdrawals that are in excess of actual income produced.
Last year I wrote a series of columns taking issue with Peter Lynch who had written that you could have an all stock portfolio and withdraw from it at a constant 7 percent rate… and still come out ahead. The idea works if stocks always provide an AVERAGE return of 10 percent but does not work when you test it with real data. In fact, if you had followed the Lynch advice going into the seventies, you would have literally gone broke.
Testing different withdrawal rates, I found that you could safely withdraw 5 percent a year. Mr. Lynch wrote another article on the subject and agreed with those findings in an issue of Worth magazine this spring. You can read the columns on my website: "www.scottburns.com" in the "Special Collections" area.
Q. Having read your column for some time, we don't recall having seen any mention of dollar cost averaging. You also frequently recommend the Vanguard Balanced Index Fund for lump sum investing. Is this to say that you would not dollar cost average into a balanced index fund? Would you put a lump sum into other balanced funds as well, or only an index fund? What about an asset allocation fund? Consider a person with a portfolio of 76% bonds, 14% equities, and 10% cash, who doesn't need the income from these investments.
To increase the percentage of equity holdings, would you recommend lump sum investing into a balanced fund, dollar cost averaging into equity funds, or some combination of the two approaches?
---T.M., AOL.com
A. Most people are dollar cost averagers by necessity: we save money slowly over a long period of time. Dollar cost averaging is one of the great benefits of monthly investment plans such as 401k, 403b plans.
Academic research, however, supports the idea of lump sum commitments to equities rather than dollar cost averaging in. The basic reason is simple: long term, stocks tend to produce higher returns and any allocation that increases your exposure to stocks will benefit from stock ownership sooner rather than later.
Research is a product of the head. Investors also have hearts and stomachs. That's why I suggest that anyone with a major sum to invest, such as a pension distribution, do it over a period of one to two years.
I mention the Vanguard Balanced Index Fund because it is a great benchmark and a no-cost place to start. With a 60/ 40 stocks/ bonds mix it has the allocation that has enabled thousands of corporate pension plans to fulfill their promises to retiring workers. In addition, it's low cost regularly puts it near the top quartile of balanced funds. That makes it a very good bet for investors who want to keep their lives simple.
File Name: 961003TH
Dallas Morning News file date: 10/03/96---THU
Universal Press Syndicate file date: same
©
Dallas Morning News, Universal Press Syndicate, 1996
