Love and Money
Setting up financial goals and a way to reach them is a great way to test your future spouse's compatibility and avoid some of marriage's nastiest arguments. And, for goodness sake, don't look for investments that just avoid taxes, look for good investments, and factor taxes into your evaluation.
By Ann Coleman (TMF AnnC) and Barbara Eisner Bayer (TMF Venus)
October 31, 2000
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Q. I need some advice. I was horrified last night when my fiance told me he wants to buy a $70,000 BMW. This has made me seriously question our future together, especially our financial future. He just doesn't seem very financially mature. Part of me says, "Run for the hills while I still can." The rest of me is, of course, madly in love. Actually, even the run-for-the-hills part of me would be running with a broken heart. It wouldn't bankrupt us, but I just think the money could be better spent on student loans, a house, an early retirement nest egg, etc. Am I wrong to be so upset about this?
A. I think you are right to be concerned, but don't anticipate a broken heart just yet. Heck, who doesn't want to buy a $70,000 BMW?
This is a golden opportunity to examine your financial goals and, yes, test each other's maturity. My one-woman crusade to reduce the divorce rate would have all couples drawing up a list of financial goals before marriage, along with a specific blueprint for achieving those goals. Not only will that eliminate a lot of fights after marriage, it will weed out the financially incompatible pretty quick. After all, if you are going to fight about money after marriage, why wait?
You might find that your fiance just needs to think about a major purchase like this in terms of priorities. Heck, one of your joint goals might be a $70,000 BMW. The question is, where does that go on the priority list? If you buy a BMW now, what do you have to give up? Economists call this "opportunity cost." Every decision you make to do one thing means you are also deciding not to do one or more other things. People often don't think about that when making economic decisions, but it's really important.
If you draw up a list of financial goals and examine each purchase in the context of what you have to give up to get it, the decision to splurge is often quashed. You've already got a good start on your list there: paying off loans, buying a house, and saving for retirement (start now and retire young!), but you can include some fun goals, too. A trip to Australia, a great car, a second home? These things don't happen unless people plan for them (or go over their head into debt, but let's not make that an option).
Once you have your goals and priorities established, you can start saving for each. Set up a timetable and see how much you would have to save to get to your goal by a certain time. (This works even after you're married.) Then, if you can see that you are making satisfactory progress toward your goals and have money left over, maybe you will feel better about buying a hot car. Or maybe he will feel better about foregoing one in favor of that trip to Australia.
Q. I have the option to invest some cash for seven years. I don't need the funds and want to avoid taxes -- who doesn't? 1) How do I get tax-free bonds or other tax-free investments? 2) Are these good investment options?
A. Let's start with the second part of your question, because I can tell you right off the bat that answering number two will take care of number one. Investing to avoid taxes is an oxymoron. You can avoid taxes with tax-free municipal bonds, but they aren't really investments. (I'm assuming that, by "investment," you mean something that has growth potential, not something like a savings account.)
Tax-free municipal bonds have a place, but it's in the portfolios of those in the top tax brackets who are looking strictly for conservation of capital and a bit of spending money on the side. You are letting the tax tail wag your investment dog.
What's most important here: How much tax you pay or how much money you have left over?
Here's a scenario: You invest $10,000 in tax-free municipal bonds paying 4% for seven years. At the end of that time, you have a grand total of $13,159, and you owe no taxes. Alternative scenario: Assume you invest your $10,000 in Standard & Poor's Depositary Receipts <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: SPY)") else Response.Write("(AMEX: SPY)") end if %> -- a.k.a. "Spiders," which are index shares that match the S&P 500. Over the past 71 years, the S&P 500 has averaged a bit more than 11% per year. If it grew at that average pace over the next seven years, you would have an investment worth $20,761 before you pay your taxes.
Assuming you are in a top tax bracket and you liquidate the whole investment at once, your tax bill from Uncle Sam would be 20% of your gain of $10,761, and your state would take... whatever. Let's assume you live in a 5% state. So, that 25% leads to a tax bill of $2,690. Big hit! Terrible! Writing that check will cause you great pain and anguish and grate on you like salt in an open wound.
However, there's balm for that wound. Still sitting in your account is $18,071. Your profit on this deal ($8,071) is twice that of your tax-free deal, after you pay all your taxes. Are you willing to give that up just to spite Uncle Sam?
That's the rosy side, but it's not the full picture. I offer it not as a choice, but as an illustration of what should be driving your decision -- finding the best investment, not paying the lowest taxes. The returns for the S&P 500 are not guaranteed and there have been plenty of seven-year stretches where they were lower than 11%.
Which brings us back to the right thing to do with that money. Bonds are great if your investment goal is strictly to hang on to what you've got. That didn't sound like what you were after, especially when you have a moderately long time horizon. So, first decide what you want to accomplish with your cash, then look for the best way to reach your goal. Taxes are part of the equation, but not the only answer.
Fool on and prosper!
