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Question for the Money Doctors

Question submitted on Apr 15, 2010.

Question

I live in Las Vegas, Nevada. I am 56 years old. My job is somewhat stable. Should I buy a second home as a rental property? I looked at some homes but the realtors tell me I must have cash to make sure my bid is taken seriously when bidding because banks look at the cash buyers first, the prequalified conventional loans second, and FHA/VA third. I can get the cash if I borrow against my 401K. Is that a bad idea? If I buy it with cash, how will I be able to get the tax deduction as a rental if the payment I receive from rent will be income because there would be no loan on the home to counter that income with? Is there a way to buy the rental home with cash and then, once I own it, take out a loan so I can show that I am making payments to offset the rental income? One more question: with my 401K I pulled out of the stock market when it hit 10,000 and went into bonds. In hindsight that was a bad move. What should I do now?

Thanks for any information you can give.

Answer

Your question regarding the acquisition of a rental home is pretty complicated. Typically, single-family residences are not good investment vehicles because their yield is so low. My experience is that investors get a cash flow after expenses of 2 to 3%. Historically, there have been times when single-family residences experienced great appreciation during a cycle.

There is no guarantee that that will recur. However, it might. There have also been times when they have experienced significant losses.

It is probably not a good idea to borrow from your 401(k) to make investments outside of the 401(k) for a number of reasons. First of all, investment earnings in the 401(k) are tax-deferred. Investment earnings outside the 401(k) are not tax-deferred. Second, an investment in a single property would lack diversification. Your chance for loss is great as many investors have discovered. Third, you expose that asset to creditors.

Investments inside of your 401(k) are protected against creditors. These are just a few of the concerns that I have regarding the purchase of a property with money brought from your 401(k).

A lot of investors who do not work with financial advisers make emotional decisions. Many people get out of the markets at the bottom and get back in at the top. An investment advisor would give you a sounding board and help you avoid emotional decisions. Our clients rode it out and did not liquidate when the market was down. They have recovered most of their money.

A recent Dalbar study showed that between 1987 and 2006 the S&P 500 returned 11.8%. The average stock fund investor earned 4.3% during that same period.

An investor who worked with a financial advisor that kept that investor in the markets would have earned 7.5% more per year, before fees. The average fee for an investment advisor for an account under $1 million is between 1% and 1 1/2%. Therefore, the investor with the advisor would have averaged 6% per year more, after costs, than the average investor.

I recommend that you develop a well thought out investment plan that dovetails with your future needs (retirement, etc.) and your risk comfort level. You could do that with the help of a Certified Public Accountant (CPA/PFS) or a Certified Financial Planner (CFP). You may locate an advisory near you at:

Find a PFS

I hope this information is helpful.


For additional information visit http://www.360financialliteracy.org/