We all know the stories of famous athletes who go broke. And then there is the infamous “lottery curse,” where winners end up bankrupt a few short years after hitting the jackpot.
Most folks think that they’re smarter than that. They believe they will properly manage any inheritances that come their way.
If only we were as smart as we think we are. As a New York Times story recently noted, adults in one long-term study who inherited typically saved just half. Over the years they spent, donated or lost the rest.
The simple problem is that many of us view financial windfalls as free money; we take it less seriously than money we earn. So what if you get a relatively small inheritance, say $50,000. What should you do first?
The first thing many people who inherit think of is to pay down their home mortgage. My advice, however, is to pause and call in a coach, an advisor, someone who can help you avoid a hasty decision you might come to regret over time.
I find many folks are bent on not having a mortgage. Yes, being debt-free is a good thing, but not if you have zero retirement investments!
I totally understand if you are set on being debt-free. But ask yourself: If you’re mortgage is $12,000 a year, does it really hurt you to keep paying it?
Let me explain. Here are a couple of numbers: 3% and 6%.
About 3% is how much residential real estate increases in value over the long term. Put another way, your home’s value is likely to keep up with inflation, more or less.
Six percent? That’s a reasonable market rate of return for a balanced portfolio of stocks and bonds. Invested, your money can grow twice as fast compared to owning a home.
I understand how fun the idea of mortgage-burning party can be. Being able to claim to have no debt is an emotional trophy, something that can be a source of personal pride. Who doesn’t want to say, “I’ve climbed this mountain of debt and now I’m done”?
Plus, people who inherit cash feel like it’s the proverbial bird in the hand. They think, “If I put it in the market I have no idea where it’s going to go, but paying off my house is real.” The data suggests, however, that home valuations tend to tread water, while stocks and bonds grow and compound.
Black and white
Remember, too, that mortgage payments are stacked with the interest up front. If you’re in the final years of a mortgage you are mostly paying for the house itself, not the financing cost. You “save” very little by paying early in this case.
That’s why anyone who inherits should talk to a financial advisor before big decisions. The black-and-white of the matter is that prudent, well-managed investments will serve you better.
Call in a financial coach. In the end, you might choose to make larger regular payments on the home — but don’t part with a large lump all at once. Watching a mortgage balance fall slowly is difficult, but retiring with a lovely home and zero money to live on is far worse.