Q. What is the benefit of a 5-year mortgage? What are the best options, in your opinion? ---S.K., by email
A. The initial interest rate on a 5/25 mortgage--- that’s 5 years of fixed rate, 25 years of variable rate--- is somewhat lower than the rate on a traditional mortgage where the rate is fixed for all 30 years.
The short-term fixed rate gets you a lower cost of interest today. But it also saves the lender from the risk of higher long-term interest rates tomorrow. Unfortunately, this also means that you will have the risk of a higher interest rate in the future. That’s a risk you should avoid, if possible.
The best candidate for one of these loans is a home buyer who expects to be selling and moving within 5 years. The only problem with this is that if you expect to be selling and moving within 5 years, you probably should be renting, not buying. While millions of upside-down homeowners will no longer believe this, homeownership has historically been a good deal for American families--- provided they were long-term owners. Most people, most of the time, should opt for a 30-year fixed-rate mortgage.
Q. I’m 52 years old. I have about $35,000 in a savings account, and I own two homes outright. But I know nothing about investing. I don’t even know how to get started. I invested in mutual funds through a salesperson and lost about $6,000. I pulled that out in 2004 and invested in natural gas with my accountant. My $18,000 investment is now down to $12,000. I am thinking of pulling out and buying an investment property (I have always made money in real estate because I do a lot of my own work).
I am tired of losing money investing. I have lost trust in investing, but I should start a safe retirement account. I have heard annuities may be a safe place. How do I find an honest investment service where my money will grow safely? ---P.C., by email
A. You won't find that "safe place" with an annuity salesman. The only safety is with government-insured CDs. That safety comes at a tough price--- virtually no yield and a near certainty that your money will lose purchasing power to inflation. The best solace I can offer is that you aren’t alone.
The best you can do is to accept some amount of risk and buy a low-cost, highly diversified mutual fund. There is no guarantee that you won't lose money, but you'll lose less money short-term. And will very likely make some money long-term.
Let me give you an example. In the 12 months ending May 30, Vanguard Balanced Index fund (ticker: VBINX, expense ratio 0.25 percent, minimum purchase $3,000) lost 18.4 percent of its value. The fund doesn't depend on smart managers who know the future, complicated investing formulas, an aggressive sales force or anything else. It simply invests in a combination of the domestic stock market and the domestic bond market. Then it delivers all but 0.25 percent of the return on your money to you.
Surely that's dumb, right? Losing 18.4 percent certainly doesn’t sound smart. Well, it's all relative. This fund lost less than 83 percent of all competing managed funds. It did better than most of the smart competition over the last 15 years as well. If you had invested 15 years ago, even with the 18.4 percent loss over the last 12 months, your compound annualized return would have been 6.9 percent--- and better than three-quarters of all managed funds with the same goal.
This unmanaged index fund also provided a higher return than 75 percent of all the managed funds that invested exclusively in U.S. large-cap stocks, 93 percent of all the managed funds that invested in large-cap international stocks, and 95 percent of all the funds that invested in intermediate-term bonds. Diversification can't protect you from a loss much of the time, but when it is combined with low costs, it is likely to give you a superior long-term performance.