Question by missfev21: personal finance help?
Bernie and Pam Britten are a young married couple beginning careers and establishing a household. They will each make about $ 50,000 next year and will have accumulated about $ 40,000 to invest. They now rent an apartment but are considering purchasing a condominium for $ 100,000. If they do, a down payment of $ 10,000 will be required.
They have discussed their situation with Lew McCarthy, an investment advisor and personal friend, and he has recommended the following investments:
The condominium – expected annual increase in market value = 5%.
Municipal bonds – expected annual yield = 5%.
High-yield corporate stocks – expected dividend yield = 8%.
Savings account in a commercial bank-expected annual yield = 3%.
High-growth common stocks – expected annual increase in market value = 10%; expected dividend yield = 0.
Calculate the after-tax yields on the foregoing investments, assuming the Brittens have a 28% marginal tax rate (based on Public Law 108-27, The Jobs and Growth Tax Relief Reconciliation Act of 2003).
How would you recommend the Brittens invest their $ 40,000? Explain your answer.
Best answer:
Answer by Ron
I find it hard to believe the condo will go up 5%. Homes are expected to drop big time over the next few years.
http://money.cnn.com/2007/09/19/real_estate/steep_home_price_drops_coming/index.htm
Then I would put down 20% or 20,000 so I would eliminate mortgage insurance and rest I would invest in mutual funds. If you are getting 5% on your money that will be less than inflation.
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There were a couple of stipulations left out of the problem statement. Mortgage interest rate on the condo is one. Property taxes is another. Both might qualify for income tax deductions provided they are greater than the standard deduction which increases the after tax yield on an investment in the condo. The condo annual increase may never be taxed so that is a 5%+++ return right there plus a savings in rental expense which may very well equal the monthly payment on the condo. But one thing lacking is the monthly maintenance expense on the condo. That is an unknown. But I think we can pretty much assume that the condo will yield an after tax return of about 15 to 20% because of the savings in rental and taxes.
Munis after tax yield assuming they are also tax free of state income tax is a no-brainer 5%
High yield corporate stocks. This is very tricky. Some are tax advantaged and some are not. The problem statement does not say which. If they are not then the after tax yield is 5.76% If they are tax advantaged, then the after tax yield is 15% (By the way 28% is not the marginal tax rate in that tax bracket. It is 25%) 06.8%
Savings account 2.16%
Hi growth common stocks. This is also a very tricky one because if the stocks are not sold they are not taxed. So the 10% grows and compounds untaxed until sold. And who knows what the tax rate might be then or for that matter their tax bracket. But for simplicity sake, 08.5%
The investment recommendation is subject to a great deal of judgement that is not a cut and dried answer.
1st off they definitely want the condo. No question about it the after tax return beats the other investment options by a mile. But they only want the $ 10,000 down so they can take full advantage of the tax breaks and use the other $ 30,000 for other things. Depending on the interest rate on their mortgage of course. They have to have a cash cushion to fall back on in case of unknown circumstances. $ 10,000 in the savings account. That leaves $ 20,000 that they are then free to invest. Dumping it all into growth stocks would be a big mistake because those stocks are very volitile. But 1/2 would not be out of the question, maybe even 3/4. The other into high yield common stocks. Forget the munis until they start really raking in the cash or until retirement.
I would recommend for them to not lock their money in bonds and stocks until after the first year of them purchasing a home. After the first year, they could then adjust their tax to see if they may owe or have a return.
As far a buying a condo and thinking your going to get 5% yearly on your return, the maket is going down and these homes will be hit the hardest. People may not see it also, but sometimes it cost more to live in condo than a home. You will have assosition dues and special assements that a regular home does not