As I understand it simply stated the time value of money says that it is better to spend money tomorrow then it is to spend it today. My good friend and colleague Frank Wallace at Colonial Penn loved to whip out his sharp accountant’s pencil and demonstrate that if we were making an acquisition or buying a plane for the CEO, it was always better to pay for it later. I think this theory holds true even if you have to borrow the money to make the acquisition. My wife, who in previous articles I have acknowledged is 10 times smarter than I, also believes in the concept of the time value of money. In today’s rate environment I think Frank and my wife are mistaken.

Let’s take the example of a home mortgage. I am all for paying it off as soon as possible. Virtually all of my financial advisors have counseled against it. Firstly, you get a tax deduction for the interest portion of the payment. Secondly, you can invest the money you would otherwise have to use to pay off the mortgage and get a higher return that the rate of the mortgage [you do have to pay tax on that income, a fact which I have always suspected that the financial advisors ignored]. My counter argument has always been that the psychological benefit of not having a mortgage payment far out weighs any small financial benefit from keeping the mortgage. Also, I believe that there is a huge flaw in the theory that you invest the money you would otherwise use to pay off the mortgage at a higher rate than the mortgage. Theoretically, this may be true. But if you invested that money in the stock market in say 2005, you would have less money now [ by 20 percent] and you still have a mortgage of the same monthly amount to pay. Maybe if you had invested in bonds of some sort you may have come out ahead. But again here are those pesky financial advisors. Any investment advisor worth his salt would have [in 2005] strongly advised you to put your money in the stock market because that is where the best returns were, in the long run. However, you now have to pay your mortgage with today’s dollars which you have 20 % fewer of.

The other thing my friend Frank Wallace taught me was that a prepaid expense shows up on the asset side of the balance sheet. So, if you pay for something in advance, you have an asset. This is also an asset that will not go down in value, like stocks. So, if you prepay your mortgage you will never lose money on that payment.

The whole idea of saving for retirement is so you can pay for necessities and luxuries when you stop working. If you put your saving in stocks you plan to use that money to pay for a roof over your head either in the form of rent or in mortgage payments. If the value of the stocks goes down, you will not have money to pay your rent. But if you have prepaid your rent, you will have a place to live even if the stock market crashes. If your rent is $ 1000 per month you have gotten $ 1000 of value for the prepayment. If you invest that $ 1000 in stocks in the hope that you will get a good return maybe you will have $ 2000, so you will be ahead. That’s the theory anyway. [But as we now know the stock market goes down and investment advisors take a fee every year]. So maybe you will end up with $ 800 instead of the $ 1000 you put in. Better to have prepaid the rent and be sure you have a place to live. The bet is intensified if you have a mortgage which can get foreclosed if you do not have enough money to pay your monthly bill.

So, let’s apply this mortgage prepayment theory to other items that you will have to pay when you retire, such as utility bills. If you could quantify your utility bills going forward [ and you will have them ], it would be better to prepay them now and have a prepaid expense on your personal balance sheet rather than an investment of uncertain future value in stocks that will have to be liquidated to pay your utility bill in the future. If you buy $ 1000 worth of electricity now you will have $ 1000 worth of electricity in the future. You don’t have to worry about a drop in your investments and since the future cost of electricity will probably go up, you are ahead of the game by buying it now. Of course, the cost of electricity [natural gas, fuel etc] could go down but when has it? So, buy what you can now of what you will need in the future and don’t worry about your investments. It also seems logical that the utility companies would be happy to take your money now on the promise of future delivery. Of course, you have to have some confidence that the utility companies will be around in the future. However, this seems like a safe bet; at least as safe a bet as collecting on bonds of utility companies in the future. On the other hand, it probably doesn’t make any sense to pay for your lawn care in advance. Those guys may not be around next year.

What about food? Maybe Wal Mart should issue script or vouchers good for food in the future. They will probably be around for the next 10 years so buy your food now, get that prepaid expense on your balance sheet and don’t worry if your investment advisor is picking the right stocks.