Burning money is a dumb metaphor

This is part 2 of the Rent vs. own series and check out RadReader comments.

The 90s electronic act called KLF (of 3 AM fame) once pulled a publicity stunt that went awry. Having only tasted modest success, they burned a million British pounds declaring that “struggling artists are meant to struggle.” Wait, what?

Clearly the act of burning money has triggering consequences on the RadReads community. There’s a strong contingent of RadReaders who believe that paying rent is like burning money; then there’s #TeamRent, best exemplified by the quote: “Do we feel like we’re burning money when we eat food? No. We’re exchanging money for a good, just like anything else.”

What is the utility of money?

Home ownership elicits a lot of emotional responses. (Evolutionary psychologists might trace this back to our primal needs of shelter and sustenance.) But in this debate, the metaphor of burning money is both inaccurate and misleading – and distracts from a broader question: What is the utility of money? To act in service of your life values and aspirations.

Stating my individual preferences

Before we dig in, I want to state my own preferences. I currently lack the income to get a mortgage (and in fact, some rentals are scared of my precipitous income decline!) Our life is now more centered around a series of family adventures. But, as I mentioned in the original rent vs. own post, I look forward to one day owning a hard asset with massive tax incentives “that tracks (and often beats) GDP growth and inflation, and [provides an easy way] for an ordinary Jane (or Khe) to get investment leverage.”

Just not today.

What does burning money actually mean?

My hunch is that when you guys talk about burning money, you’re referring to spending it. And the opposite of burning money (let’s call it “growing”), is investing. So buying the new iPhone XS, burning. Buying Apple stock, growing.

But what about, say, leasing a car? Probably burning. What about buying a car and financing it? Still burning. Y’all are right to point out that not only is a car a depreciating asset, the minute you drive it off the lot it’s lost 10% of its value. But what if that car drives you to your job every day? And that job pays you a nice salary, gives you benefits and lets you go on rad vacations? Hard to say you’re burning cash. Hell, you might be even growing it.

What about interest?

People who are not used to thinking about mortgages on a daily basis are often shocked to find out how much interest they’d expect to pay over the lifetime of a mortgage. Here’s a simple example:

Over the life of a $200,000, 30-year mortgage at 5 percent, you’ll pay 360 monthly payments of $1,073.64 each, totaling $386,511.57. In other words, you’ll pay $186,511.57 in interest to borrow $200,000.

You read that right, your grandparents (who paid off their home in full) borrowed $200k and when when it was all said and done paid $186k in interest. In addition to repaying the principal. Interest throws the whole burn versus grow debate into a tizzy.

Why? Because in the US, interest payments are tax deductible. And in a progressive tax system (like the US), the value of tax deductions generally goes up as your income increases. The value of these deductions is tied to your marginal tax rate (that is the tax that you pay on each additional dollar you earn [1]). I recommend you pop over to a tax calculator to look at your marginal tax rate.

A married couple filing jointly with $300k in annual income has a marginal tax rate of 33%. That means that if they went from renting to buying a home, the value of the tax benefit would be the interest they paid on their mortgage for the year (for argument’s sake, let’s say $50,000) multiplied by their marginal tax rate. Their tax return would give them a refund of $15k (or $50k *33%) [2].

If you’re contemplating buying a home, look at the interest component from a mortgage calculator (or find a calculator that does them simultaneously both).

Back to burning

Paying interest on your credit card debt to upgrade to an iPhone XS is probably falls into the burn category. But beyond the tax-deductibility, what makes paying buttloads of interest so compelling?

Let’s go back to our car example. Take that puppy off the lot and boom, you’ve lost 10%. A car is a depreciating asset. Homes, on the other hand, tend to be an appreciating asset. Especially over long periods of time. But I implore you, on the 10th anniversary of Lehman’s collapse, let us all remember that homes have, can, and will always have periods when they go down.

So why would you burn money on interest? It’s because of the leverage. By borrowing, you get to amplify the gains or losses on the home’s price appreciation. (See the full example here.)

In fact, here’s more proof that people actually love paying interest. There’s a type of mortgage that doesn’t require you to pay down principal. It’s called an IO (which stands for Interest-Only). The tl;dr is you pay interest (forever) and thus the amount borrowed actually never goes down. You read that right, with this very popular loan type, you never build equity. So why on earth would you do that? To maximize the tax deduction and the leverage [3, 4].

So what about stocks?

In general, stocks also tend to go up over extended periods of time (and track GDP growth). A while there are a lot of “this time it’s different” pundits, the US stock market has delivered a 6-8% real rate of return over decades [5]. Unlike a home, you can buy and sell it with an iPhone tap with zero friction.

Personally, I own and will likely continue to own a lot of US stocks. But I do want to go back to the point I made earlier:

I look forward to one day owning a hard asset with massive tax incentives “that tracks (and often beats) GDP growth and inflation, and [provides an easy way] for an ordinary Jane (or Khe) to get investment leverage.”

It’s much riskier (and more difficult) to get investment leverage to buy stocks [6]. And while stocks also have tax advantages (capital gains tax, retirement accounts such as Roth IRAs and 401ks) they pale in comparison to those offered to homeowners.

So what’s the verdict?

To be clear there’s no right or wrong answer in the debate, it’s truly a personal decision. The purpose of this series to lay out the various considerations for those making a buy versus rent decision. But we should ditch the “burn” language from our lexicon, because it’s inaccurate and misleading.

To me, money acts in service of broader life values and aspirations. When a dollar leaves your account, it can be for sustenance, investment, joy, personal growth, love, philanthropy, and much much more. A home or a portfolio of stocks are just vehicles to express these values.

I work with individual clients to determine if their money is in service of their life aspirations. To learn more, email me at khe [at] radreads [dot] co.

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[1] An easy way to think of marginal tax rate is to define it as the rate you would pay on a fictional additional dollar of income. Considering the American progressive system, your marginal tax rate rises with income and is equal to the rate of the highest tier you reach through what you earn.

[2] Any examples involving taxes are highly dependent on the state you live in, size of mortgage, number of deductions, level of income, number of dependents, and much much more. Please view this as an intellectual observation.

[3] A typical mortgage pays off a bit of principal each month. So you effectively borrow less and thus your leverage goes down over time. With an IO, your leverage stays the same.

[4] There are many different types of IOs, I’ve abstracted the details to show the example more clearly.

[5] Adjusted for inflation.

[6] This will be for another post, but stocks are volatile and the terms of most loans wouldn’t match your holding period. There could be instances of market declines which would force you to sell, which isn’t the case for a home. If your home fell in value by 100% but you could still pay your monthly payments, you wouldn’t be forced to sell.

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