Yet Another finance secret finance professional won’t tell you (but I will)

So another finance piece, as I write this the U.S. is in an official recession. This piece isn’t about recessions, inflation or politics so you can exhale. We are going to reveal another secret though that finance professionals don’t like to admit. So a quick disclaimer, I am a finance professional. I have been working in the finance and accounting field for over 30 years. This blog is not a finance advice blog; this is my own opinion based on my experiences. Any advice you receive regarding finance should be researched thoroughly by you as an investor and verified through multiple sources.

Now that out of the way here is the opening salvo “When things are good, everyone is a genius.” The last decade up until the pandemic really the stock market overall was pretty good. You had good annualized returns and many people made a lot of money. So being a finance professional and advising people to go into the market wasn’t a genius play. Of course if you aren’t fluent in finance you might have perceived it as such. Interest rates were low for a long time so there really wasn’t anywhere else to go with investing except real estate.

But the secret? Everyone is a genius when things are good, what about when things are bad? What about when you are in a bear market (when indices drop 20% in a calendar year)? The secret is, the real finance geniuses were diversified PRIOR to the bear market. Any finance professional could have told you to put your money in an index fund prior to covid and you would have made fantastic gains. The real economic geniuses advised you to diversify with money spread to commodities, bonds/treasuries, real-estate and precious metals (this is a commodity, but not a traditional commodity).

As an example, what if in 2016 your finance professional advised you to have 15% of your portfolio in “Gas & Oil”? That would look pretty good now wouldn’t it? Same with bonds, treasuries, wheat, gold… you get the picture. The secret here Is diversity of investment result in a wider spread of assets which can absorb declines in any particular sector.

Like it or not, the world still runs on Oil based products.

Now that does mean you would have had less in technologies for the same period and not enjoyed that growth. I concede that, but the savvy investor doesn’t play the short term they play the long term and sustained diversified portfolios over the long haul 10-30 years normally perform as well as a strict stock portfolio. Don’t get me wrong here, I personally believe the majority assets you are investing in should be either growth stock mutual funds or blue chip mutual funds.

100% of a portfolio though?  No, you diversify specifically for bear markets and sharp down turns because they always happen. It’s not a matter of if, it’s a matter of when and how long will it last. For calendar year 22 as of 6.30.22 the markets are down 20.3% now this has come up in July, there is no denying that but you’re still down overall. On top of that we have large inflation numbers devaluing the purchase power of your dollar. So what 1.00 would buy last year now buys .92 that’s an 8% decrease (rough estimate). That isn’t equated well in your portfolios return.

Meaning you made 10% on the stock sale but the money you received purchases 8% less than it did meaning the value of that 10% return to you in real time is a net positive of 2%. Again, the secret here is diversity. Always have part of your portfolio assigned to cash, bonds/treasuries, commodities and that will provide you a decent buffer for the next bear market because this will happen again.

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Another finance secret finance professionals won’t tell you (but I will)

One of the more successful finance posts I have on my blog is a finance secret I shared that industry professionals wont. You can find that post here.

Today I have another secret for you, it’s not a true secret as its not actually hidden but unless you are astute in finance you aren’t necessarily going to catch it. It has to do with mortgages, which in the U.S. right now is a hot finance topic. House prices in the U.S. have risen over the last 3 years anywhere from 8-25% depending on what market you are in.  House prices traditionally do not go down, they level off. If we look at a 100 years of house price data, we can only find 2 years where the median average price drops in comparison to the prior year. Again, this is largely aggregated meaning a market like Manhattan is an extreme, a rural town in Montana might be an extreme as well but on average that is where it stands.

So what is the secret? When you go for a mortgage your ability to borrow money is based on your GROSS income, not your net. It’s a trick banks use to be able to lend you more. So your ability to borrow is based on the amount you earned, not the amount you actually have to spend. The bank/lender does not account for health insurance cost, taxes, child support on and on. The good news is people who would otherwise not qualify for a mortgage can based on their gross income.

Borrowing the max amount, is a foolish move.

The bad news is exactly the same as the good, you can qualify for mortgages you would not have the ability to afford because it was based on your gross income, not your net. So you get situations where people borrow too much, you get terms like “house poor” because most of your income goes to paying your mortgage. The kicker? (well there is two) you pay for the privilege to borrow more than you can afford via interest. The other? You pay for PMI (Private Mortgage Insurance) which essentially protects the lender if you cannot pay the mortgage THEY gave you. You know the one they based on your gross not your net.

No lender is going to tell you it’s too much house, unless its WAY overpriced for your income. You have to be the one who figures this out. You need to estimate the mortgage payment and look at how much you actually TAKE HOME a month. You don’t want your mortgage payment to be more then 25-35% of your take home pay. Additionally, you don’t want a 30-year mortgage if you can absolutely avoid it because the interest alone is a killer. Banks want to lend you money, that’s how they make THEIR money via interest. It’s a tough real-estate market out there you have to be extra careful.

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