Would you refi your house to invest? I would…AM!

house_cashListening to a popular radio show this afternoon, I heard caller ask about refinancing from a twenty year mortgage into a thirty year one. The host asked, “would you borrow against a paid off home to infest?”

I would.

The host went on to point out how you need to pay off your home as fast as possible.

Sorry, but mortgages are one of the best wealth producing vehicles out there. As Dr. Dave says, “we should wake up each day and figure out how to get more mortgages.”

If you’re new to this blog then these words must sound crazy. They probably go against every piece of financial advice you’ve ever heard.

But mortgages are the cheapest form of money you can buy. The trick is to use the money to buy cash flowing assets from which you can pay off the mortgage and then keep the cash flowing asset.

The concept of investing cash from your home and is known as equity harvesting. I used a Heloc on my house to invest in VNR. The results have been great.

Don’t invest based on negative news

Something I’ve discovered when I began researching stocks deeply back in 2012: there is ALWAYS bad news. Doesn’t matter what stock you investigate. You will find bad news lurking around every corner.

It can quickly scare you away from investing in really solid companies. One of the most solid stable companies I know about is Coca-Cola. I would own some myself, except I invested in other stocks before I became seriously aware of KO’s amazing profit growing ability. I basically didn’t have the cash to start and my spare cash currently is targeted at being applied to my real estate portfolio and my EIUL.

But what happens when you add KO to your iPhone’s Stocks app and check out the news articles linked every day via Yahoo? It seems just about every week, if not every other week, someone is writing an article bemoaning the decline of soft drink consumption. Sometimes they write it and sometimes they don’t, but you are supposed to infer that this might be the time to bail on holding soft drink companies. The world is getting wise to soda, and it won’t last forever. Sorry, but KO hasn’t stopped creating millionaires yet.

Some of the other companies I’ve invested showed various dips. One of favorite examples is the first stock I bought back then: General Dynamics (GD). I bought it at $72/share. My core reasons for purchase were that GD had a strong history of earning profits and making dividend payments. On top of that, I asked myself what the odds were that they would stop making aircraft? Very low! Well, almost immediately after purchase, their price dipped down to $66/share. That scared the heck out of me! But I stuck with my analysis and held on. Today it’s trading at $117/share. Further more, I originally bought 130 shares. Now I’ve picked up an extra 3.1 shares simply by clicking on the “reinvest” button. Total growth: 60% in two years.

To add to this, don’t forget that when companies do go under, they don’t simply go POOF! Companies are actually big entities with lots of holdings. As they adjust to any current fiscal climate, they can make changes, sell of assets, refashion plans and more. Since you own a piece of that company, you will be given pieces of sell offs, splits, etc. These other companies can sometimes do quite well on their own. It may be that these various components didn’t work well when they were under one roof of management. Your equity in the company doesn’t simply evaporate because the core company trends downward.

So don’t forget to do you in depth analysis and understand fundamentally what you’re investing in. Don’t let the highs and lows of daily news drive your investment plans.

Why you shouldn’t fear bankruptcies the way the press does

If you make investing decisions based on the news, you will suffer debilitating setbacks in your portfolio time and again.

What comes to mind when you think about Sears & Roebuck today, compared to what you remember as a kid, and what you may have heard about this company decades ago? Sears was historically THE company to buy general merchandise.

I remember reading The Great Brain books as a kid. It’s a collection of stories told from a younger brother about his big brother, aka The Brain, who is quite smart, but governed by a money loving heart. Anyway, these books set back in the days when silver dollars were common currency, the character mentions having the rare and golden opportunity to order from the Sears catalog. As a kid, I remember that Sears was the place to get all sorts of stuff. But what do you think of it today? Do you flock to that store to buy things? Or do go elsewhere.

So would you consider investing in that company by purchasing its stock? Perhaps not. Take a step back. If you had the chance to buy stock in Sears thirty years ago, would you take it? Perhaps. But what if you knew everything you know now about how its gone down hill over the past years? Would you buy it then? Read this article for details on exactly how might fare.

Based on bad new stories over the years, you might say “no!” But if you actually looked at the balance sheets over that time frame, you would actually do quite well. Sears grew big and accumulated many various assets. As it crumbled, it sold off pieces into separate businesses. As a stock holder, you would hold lots of different companies, all generating profits. In fact, you would do quite well.

How can this be? As stated by the economic Nobel laureate Milton Friedman, “when companies go bankrupt, their factories don’t go poof.” Assets are sold off. New management is hired. Things are repurposed. New businesses plans laid out. Mid and senior level managers may get rolled and some employees may suffer, but in general, the core underpinnings of the company get refreshed, not burned to the ground.

This point seems to be lost on the press in general. Any shutdown of a company seems to draw reporters to find the saddest stories and turn them into headlines. They never bother to find these people a year later, and see how they are doing. On rare occasion, I saw a journalist actually find one such employee, only to discover that they were doing WAY better than before. They used to putter along with a poorly performing company. But getting tossed forced them to find something else, and they actually found something better.

Where have you been? Retail investors vs. macroeconomic investors

It may seem as if this blog has fallen off the planet. There’s a good reason. At the end of May, I signed a contract to write the technical book Learning Spring Boot. Suffice it to say, that effort has consume all my spare time in the evening. Since my work couldn’t stop, the thing that suffered was this blog. If you ever run into a chance to tap your cognitive surplus, I suggest you go for it!

Technical writing aside, I was drawn into a discussion on Bigger Pockets. In the article, Jeff Brown shows how so many investors are focused on formulae, tricks, tactics, but never on the end results.

People have horrendous savings. They aren’t loading up their 401K plans, their personal savings accounts, or anything else, on average. In fact, whenever I hear this brought up, it reminds me of a finance show on TV years ago where Ben Stein was commented how “Americans aren’t saving enough money.” I didn’t think much at the time, but the comment, by itself, is incredibly insightful. The first step towards successfully building retirement wealth is recognizing when you AREN’T.

Jeff Brown has written a couple recent posts pointing out how even IF you can rack up $1MM in your 401K plan, you’re not DOING ENOUGH. Given that almost everyone has less than $100,000, the issue should drive anyone CRAZY with panic.

In the comments, someone nonetheless brought up “retail investors,” a term minted to refer to people that buy turn key rental property. Instead of buying good deals, i.e. making money when you buy, “retail investors” typically buy what they can find and, on average, crash and burn when Murphy visits, nixing their cash flow.

I wouldn’t stand for this short sighted characterization and remarked that the path to retirement wealth isn’t confined to fix-it-up rentals. I created the expression “macroeconomic investor” since I have invested in Texas-based rental properties. Texas has shown tremendous job growth. In fact, 2006-2011 demonstrated a stronger job growth that all other states COMBINED.

When a flood of people are headed to a particular thanks to a booming economy, there is a natural consequence. They all need a place to sleep. I went on to comment:

So…I can either invest a lot of time and effort locally, or I can take my investment capital to Texas and invest there. One option requires that I invest a lot item, even potentially ending my successful career as a software engineer to get the maximum cash flow. The other option says I can invest where I’ll get higher yield, better tenant options, and newer, fresher properties, if I’m willing to sacrifice a certain overhead for others to manage it.

People love to show off their rentals. Even better, they pride themselves on finding something local and able to drive by it and show it off! Sorry, but that is amateur. Critical thing is to look at total results, and see if your fix-it-up property can generate a better yield rate than buying new properties remotely and incurring the overhead of property managers.

I have had Murphy strike twice and knock me down to 75% occupancy. Thanks to having a pro team support me, I have been cash flow positive, despite pouring an extra $1000/month into one of the mortgages to pay it off faster.

I can’t guarantee I’ll blog as frequently as I did before my current writing endeavor. But I just couldn’t keep this to myself. (Seeing some  of my past readers comment how they enjoyed my writing was inspirational as well!)

Can you really live your retirement tax free?

TaxesI have heard a lot of radio ads for various shows and products where they like to brag how you can live on the “tax free side of life”. Perhaps you’ve heard them too. If this really possible? Or are they selling a bunch of malarkey?

Let’s dig in and find out. If you’ve read some of my past entries from here, you’ll surely have noticed me talking about things like EIULs, real estate, and MLP stocks and their tax advantages. In this article, I want to look at how EIULs operate compared to a 401K in the arena of taxes.

Now before we go any further, I want to make one thing clear.

There ain’t no such thing as a free lunch, especially in taxes.

When you dig in and see how various investments operate, it’s more about picking the best, most efficient tax strategy that will serve your needs. Since this blog is about building retirement wealth, I generally talk about the best tax strategy for your retirement.

401K taxes vs. EIUL taxes

That sounds pretty vague, ehh? Let’s use a concrete example: 401K taxes vs. EIUL taxes.

If you use your company’s 401K plan, you get the nice benefit of writing off your contributions. You don’t have have to pay a nickel in taxes for every dollar you stuff into your plan…today. The trade off? (There’s always a trade off). When you start making withdrawals, you will be subject to full income tax rates on every dollar you take out.

Many people are drawn to the allure of avoiding taxes today. It sounds great to take home more pay. I certainly liked the sound of that when I got started at my first job. The problem was, there was no one there to coach on the options and benefits of other vehicles by which I could pay taxes today and pay considerably less in retirement. As the saying goes, you don’t know what you don’t know.

If you buy an EIUL instead, you fund it with after tax dollars. Every dollar that goes in has a certain amount skimmed off for Uncle Sam based on your income. Then when you decide to withdraw money later on in retirement, you do so tax free. The trade off is that by paying taxes up front, you can skip paying taxes in retirement.

Which is better? Well from a tax perspective alone, I prefer the EIUL for two reasons.

  1. The total amount of taxes I pay will smaller, because the total money in action is smaller. In general, as I get older, I make more money, and pay more taxes. So the sooner I can move that money off the tax rolls, the better.
  2. Tax rates and policies are always moving around and the subject of elections. What will this country’s entire tax structure be like in twenty or thirty years? Who knows. I’m still waiting for my crystal ball to get out of the shop. Until that time, I’ve decided that I don’t want to gamble my retirement on such a huge unknown.

If you’ve read this blog, then you know I also advocate EIULs due to better and more consistent historical performance, but I’m leaving that aspect out of this article. For tax purposes alone, it’s generally better to pay up front than later on in life. (But this never precludes doing a complete analysis!)

The tax man cometh

I’ve run into people that don’t understand why EIULs let you “get away with dodging taxes.” Some of these people I’ve chatted with tend to believe any chunk of cash you receive should be subject to income taxes.

For starters, any time you start making withdrawals from your EIUL, the first batch of money is considered return of capital. Essentially, whatever money was put into your cash value holdings is simply being handed back to you. And as pointed out earlier, you already paid taxes on it. Is it really fair to tax you twice on money that effectively didn’t go anywhere?

After you get your premiums back, then you begin taking out loans against the cash value left. Loans are non-taxable events. For my friends that believe this is trickery, I wonder if they are ready to pay income taxes every time they finance a car. If you borrow $200,000 to buy a house, do you think you should suddenly be hit up with a $48,000 tax bill that year? And what about using your credit card? Every time you use it, you are borrowing money to buy something. Should that also be taxed?

I’m sure you don’t want to pay taxes on any of that debt, but what’s the underlying reason you shouldn’t? Because you will ultimately pay off your debt using taxable dollars. The government WILL get their cut of money based on this debt. They just get it in smaller chunks. Bought a $20,000 car? You will end up paying it off with $20,000 of hard earned money subject to good ole’ income tax laws. In fact, thanks to financing, you might actually be shelling out a little bit more, all paid with taxable dollars.

But wait! EIUL loans aren’t paid off!!! How can you justify THAT?!?

An EIUL is a life insurance contract. The amount of money you pass on to your heirs is tax free. It is an enticement by the government to leave something to support your family, friends, or whomever you wish. When you take out loans, the loans+interest are paid off by the death benefit. And don’t forget: it was funded with after tax dollars.

So as I wrote early on, there is no free lunch. You aren’t “getting away” with anything. You funded a plan with taxable money and structured things so that you could pay the taxes now instead of in retirement.

Mutual funds are just fine…if you’re rich

rodin_thinkeI listened to a famous financial radio host talking on another radio show this morning. The question was asked, “do you still believe in the 401k?”

His answer? “I invest in some mutual funds in a 401k along with rental property I pay cash for.”

I listened to this and could immediately see the fallacies in such a statement. Let’s dig in and examine them.

First of all, the key to building a retirement portfolio is putting money there. Duh! The reason many of us read a report or a prospectus is because we don’t have gobs of money to fund a portfolio. Instead we have much less so we must lean on the power of ROI and compound interest.

What do I mean? Imagine you made $1,000,000 each and every year. What if you could live off just half of that? I promise you: saving $500,000 every year for twenty years will set you up real nice.

With no growth at all, that adds up to $10 million. And if you bought something that yielded a paltry 1%, you would be raking in $100,000 forever without dipping into the principle.

Instead of plowing half a million into some 1% CD, what if you peeled away half of that and bought a new rental every year all cash? I think accumulating twenty rentals would be very nice.

$5 million in rental equity could easily yield $20,000/month in rent. Apply Murphy’s rule and assume you only get half due to repairs, maintenance costs, vacancies, etc. $10,000 is still pretty good.

Combine that with an adjusted $4000/month in CD interest, and you will do just fine.

As a side effect, people would probably stand up and take notice. The synergistic effect would let you write books that would sell like hot cakes because everyone would want to know how you did it.

So how did you do it? The secret is the original business you built that generated all that capital in the first place!

If none of us become entrepreneurs, we have to think up other ways to scrape up some capital. If your rich, you can afford to pay all cash. Not rich? Then your stunting your returns by going too debt-is-evil. There are good ways to take in debt and mitigate the risk.

Make no mistake. We can still accumulate $5-10 million in rental property. We just have to be ready to take on strategic debt, hire the right experts and do things smarter. We have to keep our eye on the ball.

We can become very successful. Sadly no one will want to read a book about how we did it. Oh well. You win some you lose some

But it irritates me when certain rich people go out of their way to tell us that mutual funds are great for everybody. They’re not. They suck. It just doesn’t matter how badly they suck when your pile of gold is really big.

To generalize that this approach to building retirement wealth works for eveyone is ridiculous. History doesn’t support it. And this is where I must part ways with this radio host when he begins to talk about investing.

Rental property requires patience…and cash

habit-saving-moneyIt looks like we finally have tenants for my unit that has been vacant since the end of January. We’re talking three months of lost rent. In that time frame, I have had to pay for utilities. I will also have to pay a finders fee to my agent that located these tenants.

Last year I instituted paying an extra chunk of change on the smallest mortgage. Basically I was pushing the bonus rent into that mortgage to pay off as fast as possible. Turning it off was too hard, and I assume it would get filled quickly, so I never turned that off. It has made me cash flow negative for this short time frame.

Perhaps I should have turned it off immediately. I need to think that through, make a plan, and go through with it the next time we have a vacancy.

Do NOT act desperately

Having one applicant fall through, another possible applicant pass on behest of finding a better deal has given me every reason to get desperate. What do I mean?

Just last week, I had an applicant shoot to get the unit. The trick was, they had been foreclosed on and actually had a huge outstanding judgment to pay. I wanted a tenant, but I knew I might be taking on someone that would cost a lot more money to get out of. So I passed. And then in the middle of this week, I got a couple college kids who have their parents ready to co-sign.

Things looked much more solid, so I jumped at it. They want to move in today. Not sure all the paperwork can get pushed through that quick. But it will be nice to get the rent flowing again.

Do what makes sense, NOT what feels better

Most of this time, I had a persistent feeling that having an empty unit was bad. It pushed on me, stressed me, and strained me. But I KNEW that I needed to pick up a solid tenant. The cost of not waiting for such would probably any carrying costs.

I also knew I had a LOT of cash in the bank and could ride this out. Too little cash, and desperation can easily become reality. I had the benefit, thanks to Jeff Brown’s insistence on cash reserves, to weather this storm until a good tenant could be found. Well things look solid, but only time will tell if I picked the right people to rent out my unit.

And I get to through this again next month as another one of my units becomes available at the end of this semester!

When dealing with banks, assume NOTHING

house_cashMy four rental property mortgages came up way short in escrows this year. It meant they were going to increase my monthly payments by a huge amount. I discussed it with my real estate broker and my mortgage broker. It was agreed that it would be better to plunk down the cash to pay off the shortages. But that isn’t the point of this article.

You see, a month ago I sent checks in to pay off the shortfall. This was needed before I could request they stop collecting escrows. As this month’s payments went through, I noticed a shortfall still being reported on the website. I called them up, and sure enough, they had NOT applied the checks towards the escrow shortfall. Despite the checks being labeled as explicitly to be paid towards the shortfall.

Instead, the bank put the money towards this month’s payments. The extra cash in a couple of the checks was applied towards principle. When discussing this over the phone, I asked if they could reapply the checks. “No.” Essentially, what was done, was done.

I had dropped a chunk of cash and my issue wasn’t resolved. I hammered things out to get the balances paid off. It was quite a bit of cash to straighten things out.

Not only does this reaffirm the need to carry big cash reserves, it also highlights that anytime you need do anything different than make a standard monthly payment, don’t assume the bank will do it right. Call them up and make sure they are doing what you want with your money.

Checking ALL the facts

rodin_thinkeSkimming some financial forums, I once again spot people making gross assumptions with inadequate facts.

One popular discussion is whether or not you should pull out your 401K money, pay all those taxes including the extra penalty, and buy rental property.

People LOVE to point out the superior option of rolling your 401K money into a self directed IRA and using that to buy property without any tax repercussions.

And once again, such advice is rarely challenged as not a good bet. People seem ignorant that no bank will write you a note for only 25-30% down if it’s from an IRA. For a non-recourse loan, they will probably want more like 40-50% down.

It kind of kills the whole effect. If they are cutting the number of rentals you can buy in half, what’s the point of dodging the taxes?

Factor this too. IRA funded rentals require all proceeds to go back to the account. You can’t “touch”‘any of the money. It’s not an option to write a check at Home Depot for things and fix it yourself. You have to hire a contractor.

With the net effect canceling out your tax savings, you might as well just pull out your money and leave all those pesky regulations in the rear view mirror. After a few years, the penalties will probably become a distant memory.

VNR increases monthly distribution by 1.2%

newlogo7.9.10VNR has announced April’s distribution will increase by 1.2% to 21¢/unit. That doesn’t sound like a lot but consider that the previous rate only ran for seven months. The previous rate went for only three months, and the one before for six months.

If you tabulate growing from 20¢ to 21¢ in 16 months annualizes to 3.7% growth of distribution. That’s not bad, but it’s not the best. According to the Rule of 72, it will take 19 years to double the distribution. But I’m willing to put up with this because the annual yield is around 8.5%, which is pretty good.

The only thing I need to fine tune is the timing of my payments on my HELOC. The due date is the 15th of the month, but I usually don’t get my distribution until the 15th or sometimes a few days later. Given the time it takes to cut a check and mail it to my bank, I am planning to pay the HELOC on time, and then transfer the distribution into my checkbook, backfilling the earlier payment.