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november 2006

Salem business Journal

The Power of leverage

Buying a home can be a great investment. However, the wealthy buy homes with as little of their own money as possible, leaving the majority of their cash in other investments where it’s liquid, safe and earning a rate of return.

This month’s article is to a large extent a continuation of an article that appeared here several months ago. It garnered a decent amount of attention, so I thought I would revisit some of the topics covered in that article here. So with that in mind, let’s delve in.

One of the biggest misconceptions homeowners have is that their home is the best investment they ever made. The reality is that financing your home was the best investment decision you ever made. If you purchased a home in 1990 for $250,000 and sold it in June of 2003 for $600,000, that represents a gain of 140%. During the same period, the Dow Jones grew from 2590 to 9188, a gain of 255%. When you purchased the home, you only put $50,000 down, which produced a profit of $350,000. That is a total return of 600%, far outpacing the measly 255% earned by the stock market.

The Cost of not Borrowing (employment Cost vs. Opportunity Cost)

When homeowners separate equity to reposition it in a liquid, safe side account, a mortgage payment is created. The mortgage payment is considered the “employment

Mortgage views:

cost.” What many people don’t understand is when we leave equity trapped in our home we incur the same cost, but we call it a lost “opportunity cost.” The money that’s parked in your home doing nothing could be put to work earning you something. Let’s say you had $100,000 of equity in your home that could be separated. Current mortgage interest is 6.25%, so the cost of that money would be $6,250 per year (100% tax-deductible). Rather than bury the $100,000 in the backyard and give up the “opportunity” to earn a rate of return on our money, we are going to put it to work, or “employ” it. By separating the equity, we give it new life. Assuming a 28% tax bracket, the net employment cost is not 6.25% but only 4.5%, or $4,500 per year after taxes. It’s not too difficult to find tax-free or tax- deferred investments earning more than 4.5%. Using the tax benefits of a mortgage, you can borrow at one rate and earn investment returns at a slightly higher rate, just like banks and credit unions borrow our money at 2-3% and then loan it back to us at 6-8%. It’s what makes millionaires, millionaires! By using these principles, you can amass a fortune.

how to Create an extra Million

David Chandler

dollars for retirement

By repositioning $200,000 into an equity management account, you can achieve a net gain of $1 million over 30 years. Assume you separate $200,000 of home equity using a mortgage with a 6% interest rate. If the $200,000 grows at a conservative rate of 6.75% per year, it will be worth $1,506,649 in 30 years. After deducting the $232,000 in interest payments and the $200,000 mortgage, you still have $1,074,649 left in your account—a net gain of over $1 million!

Imagine how the numbers grow for individuals who reposition their home equity every 5 years as their home continues to appreciate. This is how the wealthy continually increase their net worth. Conversely, if the same $200,000 were left to sit idle in the home for 30 years, it would not have earned a dime! The home appreciates based on market conditions, regardless of the amount of equity in the home. Whether that $200,000 is sitting idle in the home, or whether it’s conservatively invested outside the home will have no effect on the appreciation rate of the home. Home equity is the equivalent of stashing money under your mattress or buried in a tin can in your backyard. It’s clear to us

Jenga Anyone? Telling Your Story: Mary Louise VanNatta, CAE The importance of stability in group management

My family likes to play Jenga®. The game has 54 precision blocks and the goal is to take risks by removing and replacing blocks, building a taller tower without collapsing the structure. Jenga, in Swahili, means “to build” and whether you are talking about the game or your organization, the goal is to build it, while keeping the structure solid.

Fairly quickly, even the kids learned that the weaker the Jenga base is, the quicker it falls. This is consistent with most areas of life. Whether you are part of a nationwide organization like AAA or a small Rotary Club, proper organization and a stable foundation will support great leadership and attract members. How many times have we seen great leaders or charismatic chairpersons who are unable to succeed because they aren’t supported by staff, volunteer or club administration? Today, I’d like to make a case for the elements of stability that will keep your organization going strong.

The most

important

parts

of

club/

association

foundation

are:

1.

The

establishment of proper organizational procedures, 2. The quality of the data and record management, and 3. The quality and the transparency of the financial recordkeeping. If a group fails at any of these elements, the organization is destined to be too fragile to withstand leadership changes or “Acts of God” that could disrupt

or collapse their organization.

As

for

organizational

documents,

those include: Articles of Incorporation, Bylaws and other policies and procedures. Generally these cover election procedures, board terms, voting, dues, etc. These should be (or have been) written to last, so have your attorney consult with you on the proper and mandatory items to include. You don’t want your Board members to constantly enacting changes to make them function for the organization. Items not necessary for the Bylaws should be placed in a “Policy Handbook.” They can cover items such as reimbursements, use of letterhead and mailing lists, etc.

Many groups underestimate the value of their data. Our President, Harvey Gail, always says, “Whoever has the data has the power.” Without easily accessible data, you will be powerless to communicate with your members and you will spend a lot of time

looking for information. Recently, I attended

an

Association

Management Conference and heard Susan D’Antoni, former Executive Director of the New Orleans Medical Society. As you can imagine, she and her office had to abandon the association during the hurricane. She gave us a good reminder about the

importance of having data storage in remote locations and in electronic form. Most small groups will not have this problem, but if only one person keeps the mailing list on a computer at his house, it would be wise to make multiple back-ups as well as a hard-copy. The more professionally the data is managed, the more useful it will be to you to communicate with members- translating into better meeting attendance and participation.

Finally, your organization needs to place importance on good financial management. If your treasurer is selected by rock-paper- scissors, or the checkbook travels from member to member each year, you might

want

to

revisit

your

system.

You

need

to

watch your cash, bookkeeping.

your

checks

and

your

Not all organizations can have financial professionals manage their funds, but you can minimize your risks by involving more people in financial oversight. Every group should have a budget and rules that sets spending guidelines. At a minimum, you should have two leaders watching over cash collections and counting for verification purposes. Your volunteer treasurer should not receive the bank statements, unless someone else also gets a copy every month.

Page 21

neither of these are efficient uses of money, as they are not earning anything but more likely actually losing value due to inflation. However, if you would not stash $10,000 under your mattress, why would you want to keep $200,000 sitting idle and dormant in the form of home equity?!?

Betting the ranch: risking home equity to Buy Securities?

Home equity is serious money. Liquidity and safety are the key philosophies when separating home equity. Avoid highly volatile or aggressive investments. You can make thousands of dollars by simply borrowing at 6% and investing at 6% in safe, conservative, fixed investments. In general, individuals should not invest home equity for “current income” unless the investment is fixed and guaranteed. Recently, the NASD advised against separating equity if the client must rely on the investment returns to make mortgage payments. Individuals interested in variable investments should ask

Continued on page 23

Checks over a certain amount should have

two signers.

Proper independent

audits

should be held regularly.

As for financial reports, “We have money, don’t worry,” is not a proper treasurer’s report. Financial reports should include a b a l a n c e s h e e t , p r o fi t - t o - l o s s r a t i o s a n d

budget-to-actual reports.

A budget is

necessary to organization

guide spending and force the to have the conversation about

expenditures.

Non-profit

organization’s

goals are not

to gather

large reserves;

however, proper vision and stewardship will make sure the funds are being spent in a way that reflects the organization’s mission. Reports should be transparent and easily understood by non-financial professionals. Near the end of our family game, we learned that the Jenga tower will not stand on a single block. If your group is built around the “passion” of a single volunteer who “does

it

all,”

it

is

critical

to

begin

cross-training.

Too

many

times

I

have

sat

through

meetings

where

nothing

can

be

accomplished

because

Continued on page 23

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