No one wants to think about losing their job or large amounts of money in the stock market, but these occurrences happen. The best advice is to start planning well ahead of time. Let’s use a real-world example. Say that there were two people, each of whom buys a house for one million dollars, and each of them also has one million dollars in investments. One of these people hates debt, so he takes that million dollars and pays off his mortgage. He now owns the house free and clear. But the other homebuyer asks for our advice, and we recommend to her, “Take out a mortgage for as much as possible to preserve the cash you have in your investment account. You will have this money in the event of an emergency, it will continue to grow wealth by compounding, and you will receive extra investable cash by having the interest as a tax deduction.” Now, let’s make the situation dire and assume that both of these people suddenly lose their jobs. What choices do both have? He has a million-dollar house he owns free and clear, and she has a $600,000 mortgage and $600,000 in investments. They’re both good at their job and will more than likely find a job at some point in the future. But that doesn’t always happen right away and they might have to relocate for their new job. It’s a process that could take six months, a year, or even longer.
The person who thought he was making a wise decision and paid off his house in full, now has to worry about cash coming in and feeding his family. And what about heat, light, home insurance, and property taxes? His options are limited. He may go to the bank to which he’d paid his mortgage and ask for a home equity loan, but because he has no cash flow, no job, and no liquid assets, he’s unlikely to get it.
Or he could decide to put his house on the market in hopes of a fast sale, which may mean that he’ll have difficulty selling it for the price he wants. He needs cash quickly, so he has to sacrifice the price he gets, maybe letting his house go for far less than it’s actually worth.
Let’s check-in with our other laid-off executive, who is also a homeowner. Remember, she took our advice on taking out a $600,000 mortgage rather than paying for the house outright, which means she still has $600,000 in cash or investments that she can use. Her job situation isn’t ideal, but her money is generating cash flow (interest, dividends, or capital gains) to cover her expenses. Plus, if she goes to the bank for a home equity loan, having a comfortable cushion of investments makes it far likelier that she’ll get that loan. She also probably won’t have to sell her house and sacrifice its value. The person who has no accessible liquid assets and no debt has few or no options. The person who has accessible liquid assets and debt has many options.
It’s never fun to think about these dire circumstances, but it’s important to plan and prepare for them. For more information about preparing for the worst, visit www.tswealth.com.