Why Your Planner Wants You in Debt

I saw this little article in the May 2007 issue of Money and had to share it with you because it is related to all my mortgage posts. Unfortunately, there’s no link available so I’ll have to tell you what it is about. On page 40B of the May issue of Money there is a column called “the mole,” which is written by an anonymous financial planner. In this particular column he says:

“Recently I was talking to a client of mine who has a second mortgage at 8%. As we went over his investment options, I suggested something he had never heard before: He should pay down his mortgage.

“Most financial planners would rather memorize actuarial tables than have you pay off a mortgage. They’ll say, ‘An 8% mortgage costs you only about 6% after your interest deduction. I can do better than that in the stock market.’ Well, yes, perhaps it’s true, but the stock market isn’t a sure thing. Paying off your mortgage is. A fairer comparison would be putting your money in risk-free Treasuries. Sure, paying off an 8% mortgage really means a return of around 6% after taxes, but Treasuries pay just 4.6% or so (around 3.5% after taxes).

He then goes on to say that the main reason planners don’t suggest paying off mortgages early is that it would mean that they (the planner) would make less money since they are typically paid a percentage of your invested assets. Assets used to pay down a mortgage would mean less assets for the planner to manage, which means less income for them.

If this were true, wouldn’t these same planners recommend that their clients NOT pay off their credit cards? I don’t know of any financial planner who would recommend that a client NOT pay off their credit cards. I realize that most clients aren’t going to have mortgage-size credit card debt. I think most planners would look at this as more an issue of what’s the best way to allocate your resources than they would worry about losing out on assets under managment. I mean, shouldn’t a planner’s responsibility be to help their clients grow their net worth? This means making decisions based on the known facts and weighing that against the possible outcomes. Sure, some people will be more comfortable paying off the mortgage quickly. Others may want to put it off as long as possible. I think it should be between the planner and the client to make that distinction.

17 thoughts on “Why Your Planner Wants You in Debt”

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  2. I’ve decided to forgo making extra payments on my mortgage, but I believe I’m in a special situation. My wife is disabled and has disability but not W2 income. If I were to be hit by a bus or something, she has no opportunity for Traditional or Roth IRA contributions, 401(k) or 403(b).

    If she’s sitting on a pile of life insurance money, she always has the opportunity to pay down the mortgage. But only I can invest in tax-advantaged accounts. So that is where I put my priority.

  3. I am amazed that many people still do not recognize the conflict of interest between themselves and their professionals when their professionals are paid a commission based on the advice they give. KMull is correct — a fee based planner is the way to go.

  4. JLP, the difference between a financial planner suggesting paying off your mortgage and paying off your credit card debt is the difference in interest rates. A financial planner thinks that he can make you better than a 6% return(in your example) by investing your money. But no honest financial planner thinks that he can make you better than 15 or 18% that credit card debt is charged.

    As for me, I do both – pay down my mortgage and invest.

  5. People want to pay down their mortgage because they want to feel free. Your house payment is probably your largest monthly bill. When one thinks about it, one can’t help be feel a massive rush of endorphins at the thought of not making that payment any more.

    But, you’re not free. Unless you either inherited money, or earned a consistant massive paycheck, you probably undersaved and underinvested during the time you were making extra principal payments. And that would leave you unprepared for retirement.

    If I can take my $200,000 or so dollars, and grow it into $1,000,000 in the next 12 years (assuming a modest 15% increase in your net worth a year), then in my opinion, it will not matter that I paid all that mortgage interest. My yearly goal is 20%, which would have my $200k hitting $2 million in the same 12 years. In my humble opinion, my house and its related debt starts to really shrink in comparison.

  6. I think its a good idea for people to recognize that in most instances, there are conflicts between themselves and their professionals:

    – Lawyers paid by set fee are incented to use short-cuts
    – Lawyers paid by the hour are incented to be more verbose
    – Planners paid by commissions have product bias
    – Planners paid by retainer fee have less incentive to grow your portfolio
    – Accountants are biased towards tax-advantaged invmts
    – Mortgage brokers are biased towards getting you the biggest loan you can qualify for
    – Real estate brokers are biased towards getting you into the biggest house you can “afford”
    – Physicians are biased based on their specialty – Surgeons like surgical solutions, etc.

    And so on. The only person completely aligned with your best interest is you. Trust nobody. This is not to say that these people aren’t trustworthy – I wouldn’t hire them if they weren’t. But, at the end of the day, they do not have to live with the decisions at hand – you do. And human nature, being what it is they are conditioned by training to favor certain solutions over others and try to fit their solutions into your problems.

  7. Miguel makes some great points. Any professional should explain their pay structure to you and should not be offended when you ask them.

  8. I’d be willing to bet that this person has _two_ mortgages, probably because they did a 80/20 or 80/15/5 mortgage split to avoid PMI on a bigger first mortgage when they bought their house. 8% is awfully high for a first mortgage and is in subprime-land. 8% isn’t so bad for a second mortgage.

    In this case, paying down the second mortgage aggressively makes a lot of sense. If the first mortgage is a 30 year fixed with an interest rate under 6%, it probably isn’t worth paying down aggressively.

  9. I like the way this mole thinks. A mortgage is really a negative bond. Just think someone else may be holding that mortgage, it might even be you!

    Adjust your asset allocation according to your risk accordingly.

  10. What a shame that we must always have our suspicion hat on. It’s true though–many professionals think only about their own pockets and not the best interests of clients.

    I think Sam has a good point above. It would be very difficult for anybody to claim a strategy which returs a higher percentage than credit card APRs. However, the mortgage argumet goes both ways. I did a post on “Missed Fortune” finacial planning recently with the same suspicion–that many planners will ask you to create debt simply to free up more money for them to invest. However, I got a LOT of responses from both planners and individuals who had success using insurance products with guarantees.

    I’m still skeptical about it–but I’ve leared to at least listen to every strategy out there.

  11. It’s not so much a question of conscious bad intent – it’s just a question of “running home to momma”. A financial planner will typically focus on the top-line of increasing net worth by better investing versus focusing on the bottom line of doing so by decreasing expenses and paying off debt. And that isn’t a bad thing: one shouldn’t need a financial planner to tell them to pay off credit cards, but one may want one to help them with investment strategies for retirement.

    As for “running home to momma”, everyone does it: we focus on problems closer to our knowledge domain since we can apply our experience to fixing them. Problems that may still matter greatly, but are outside our knowledge domain, will often get treated as a by-the-way thing: at best, the financial planner would say “pay down your credit cards”. He would be unlikely to say “use the snowball method and here’s some cash management and budgeting strategies that help you pay down debt”. After all, a credit counselor would know this but it isn’t likely that a financial planner made deep study of these sorts of things.

    As long as you know that people have different specialties, and are inclined to analyze your situation through their specialties, you’ll be fine.

  12. Fee or commission doesn’t matter, planners still have a conflict of interest. It’s just easier to spot the conflict for a commission-based planner.

    The majority of the people out there would be best suited with an extremely simple savings strategy. Scott Adams outlined it in his unified theory of everything financial.

    Professionals excel at making things more complex than they need to be. That’s how they justify their existence. The same applies to accountants, lawyers, doctors.. Yes, some people need more complex assistance but 95% of the population doesn’t.

  13. Forget about my financial planner – my wife wants us in debt because there are things she’d rather spend the money on (not realizing, of course, that we’d have more money if we weren’t making monthly payments).

    That being said, I’ll have to take any financial planner’s advice with a grain of salt. Which makes me think, “Why do I need a financial planner in the first place?”

  14. “Why do I need a financial planner in the first place?”

    For the same reason you’d go to a doctor or lawyer for certain things, or hire a carpenter for that matter. Some matters are more complex than our knowledge-base. Or, even if they are not too complex, we simply do not have the time or resources to climb the learning curve and develop the expertise on our own.

    My earlier point was that ultimately you have to be the arbiter between all the professionals you hire. You have to learn enough about the subject to be able to select good professionals, and filter their opinions thru your own judgement. They all come with a point of view, often shaped by their professional training. The carpenter may want to do it his way, the way he was trained to do it, but you might want something asthetically different. So, it is with doctors, lawyers, and planners.

    I argue with my own planner constantly. We debate various strategies. I don’t take her word as gospel, because she’s only human. She doesn’t have all the answers (even if she thinks she does). But, she is still a valuable resource.

  15. I get Money Magazine and that article made me think. Is it really better to invest money rather than pay down a mortgage?

    I used an online amortization and compound interest calculator to see with a 6% return and an 8% interest rate (which according to the article ends up being 6% after tax deductions). If you pay down and end your mortgage say, 10 years early, you do end up with more money invested (assuming the market stays true) than you would have saved in interest.

    But then I thought, now I’ve got 10 years without a mortgage…what can I do with THAT money? Invest it! So I invest my mortgage payment for 10 years, figure in extra taxes I must pay, and with the same return plus the interest I save you actually come out ahead at the end of 30 years.

  16. Financial planner has known facts and weighing against the possible outcomes of their clients. It only means that they also knew if that is negative or positive for us client.

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