This article was updated to correct the author's name.
By Cherice Chen
NEW YORK (AdviceIQ) — What's on your dream list? A yacht? A Lamborghini? Or a house in a summer resort? Well into your career and financially secure with extra money to spend, you now look for a treat, a reward for all the hard work of your youth. Advisers, however, have some important caveats for you when you plan to make such luxury purchases.
When people buy high-value items, the excitement of realizing their dreams can carry them away. A financial adviser's job is "not to kill that excitement, but instill a sense of practical reality" in decision-making, says Ray Ferrara, president of ProVise Management Group, in Clearwater, Fla.
One common mistake people make when emotions are running high is that they fail to consider all alternatives. A used boat is much cheaper than a new one, for example; and renting a summer house can be more cost-effective than owning it. When people set their eyes on their desires, they even forget to talk to their advisers first, says Lawrence DeNoia, president of ITI Strategies, in Peekskill, N.Y. One of his clients, DeNoia says, showed up one day in a $60,000 yellow Hummer. DeNoia asked him why. He said he "always wanted one."
"An adviser's job is to make sure you don't run out of money," DeNoia says. "But because of this purchase, his money in the account could not last as long as I intended. That's dangerous."
Some people also suffer the "once you have it, you don't want it anymore" syndrome. Advisers suggest if you are not sure you will enjoy your expensive new toy long enough to get your money's worth, do some test runs. You don't want to buy a boat only to find out you get seasick easily. Join a boat club or rent a boat first. Dip your toes into the water to decide whether the purchase really makes your life better.
If you are emotionally ready, here are some financial considerations to figure out how much your goodies really cost.
1. Is it a purchase that depreciates or appreciates? The value of some luxury purchases can go up over time — for example, a house or artwork. Others, such as cars and boats, diminish in value. There are times when all you buy is a great experience — an around-the-world cruise, for instance. Factor in inflation's effect too.
2. How do you pay? Do you pull funds from your savings and investments, from your cash account or get a loan?
"Generally, you should never go into debt for luxury goods," said Mark Foley, president of Pendo in New York, especially for things that depreciate. It is a double blow to pay interest for something that loses value.
You also don't want to dip into your investments for consumer purchases. If you really need to, Foley says, liquidate the lowest-yielding investments first. For example, your certificate of deposit that pays 1% interest should be first to go, rather than a stock that has a 5% dividend yield.
3. How long do you want to keep it? Do you intend to hold onto your luxury goods forever? Likely not. How much can you sell it for when you don't need or want it anymore?
4. What extra expenses are there? The number on the price tag is not all the cost. Commissions, insurance, maintenance and dockage, for example, are extras. And if you want to sell your stuff, such as a summer home, you may incur tax consequences.
5. Don't forget the opportunity cost. When you take out money from your portfolio, you lose the growth you could otherwise have on it. If the expected after-tax return on your portfolio is 6% a year and you withdraw $200,000 to buy a sports car, the opportunity cost is $12,000 for the first year and increases over time. That's another reason not to invade your investments for fun purchases.
Buying luxury items involves a lot of decisions and, sometimes, give-and-takes. Go to your adviser to crunch the numbers. If the price for your desires exceeds your capability, don't jeopardize your financial security for something you could do without. Seek alternatives. DeNoia suggests that his retired couple clients interested in relocating to Florida for at least part of the year not commit to another 25-year mortgage on a house there. It's better to rent one for a couple months for vacation.
If you can afford it, per your adviser, without changing your current lifestyle, there's nothing wrong with rewarding yourself with the money you earn. Ferrara, for instance, suggests that his retired Fortune 500 executive client buy the private plane he wanted.
"There are always trade-offs," he says. "If you have the cash flow to do so, and like it, go have fun."
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