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.

Having the right team pays BIG!

DSCN0002Once again, having the right boots-on-the-ground team to manage my real estate has paid off. I mentioned before about a tenant that received military travel orders to report to another base at the end of January and had to break his lease.

Fast forward to March, and we still don’t have a new tenant. We had one lined up a month ago, but their ability to sell their previous house fell through.

I received an email that a couple that had sold their prior house and was building a new one. Until their new home is ready, they are asking for a special short term lease (eight months). To support such a special lease, a premium of $200-300 was suggested by the property manager.

I picked up the phone and called my real estate agent that finds tenants. She boiled it down real simple. My unit was the only one in the area ready to go RIGHT NOW. The wife is a realtor and the husband works for the police department. When I first read that, it sounded like two people that probably had solid character. My local agent was able to tell me that she actually knew them and gave me a good read on things.

Don’t get sucked into analysis paralysis

I had already punched in $300 x 8 months and saw that I could recover the lost rent from two months of vacancy. And if things drag out, they might have to stay longer. That combined with the solid reputation these potential tenants had, it was a no brainer. I told my agent to pull the trigger and start the application process.

It’s important when opportunities rise, to jump on them and not waste too much time calculating things. Having a local professional that understands the local market is invaluable. I can follow a lot of things, but being able to call my agent or Jeff Brown and have them boil away all the irrelevancies while focusing on key factors is important.

My agent explained that there were more units that would be coming on the market soon, but mine was the only single-floor home available RIGHT NOW. I told her to pull the trigger!

When this short lease runs out, I’ll call her again and we’ll see what rents rates are like at that time. But it will feel good to catch up cash flow wise and even pull ahead.

Financial math often isn’t straightforward

wealthWhen you decide to pick up the gauntlet of investing for retirement and step away from passively throwing money into your company’s 401K plan, you may enter a perplexing world. Don’t be afraid!

For starters, you might start visiting lots and LOTS of websites looking for opinions. Be aware: many people can and will state opinions wrapped in feel-good language like “think about…it makes sense”. It doesn’t make it right. That’s why you need to learn how to drive a spreadsheet and crunch numbers on a calculator.

The only way to really deduce if they are right is to do the math yourself. This might involve either using a calculator or a spreadsheet. Another tool to have at your beck and call is a mortgage calculator.

Let me pick one example. I have a primary residence, a vacation residence, and four rental properties. They all have mortgages. So what do you do if you stumble across a surplus of cash? Try googling “pay off mortgage early” and you’ll find loads of opinions. People often suggest paying off your primary residence first. Many will state it is way more important than paying off rental mortgages. They’ll probably mention a dozen different reasons.

But simply put, your permanent residence doesn’t yield cash. The only way to get that money back is to SELL your permanent residence. You ready for that? In my situation, no. I’m not moving anytime soon. Sinking any extra of today’s dollars would be flat out stupid.

The plan is to knock out the rental loans as fast as possible to make it an option to liquidate a unit when the time if right. That combined with the accelerated depreciation I’ve set up will generate the biggest bang for the buck.

A finer point in this example is exactly how various pay off scenarios impact the bottom line. Currently, I’m piping extra rent towards the smallest rental mortgage every month. I’m interested in throwing a one time payment against it next month. What impact would it have?

Learn how to drive a spreadsheet and a mortgage calculator

Like the title says, some things just aren’t intuitive. I found a mortgage calculator that includes the ability to add extra on a monthly, annual, and one time basis. The extra monthly amount I’ve been paying is bringing the pay off date from 2042 in to 2020. Nice! What does my tentative single payment next month do? It pulls the payoff date in six months. What?!?! I thought it would have a bigger impact. It doesn’t. The question arises: is this the best usage of such money?

This discovery also raises the question about what if I could make an annual contribution to the rental mortgage? I began to go down my laundry list of extra sources of cash. The two I can think of is using one of my 6-month bonus checks or one of my 6-month ESPP options. The bonus check is currently used to fund my vacation property. But what if I routed one of my two ESPP checks into that rental property? I hastily punched it into the mortgage calculator in lieu of the one time contribution. I see the payoff date move up to 2017, just three years away. That’s more like it!

I’m planning to have a review of everything with Jeff Brown. I’m going to tell him that I can pipe extra cash annually, or even twice a year courtesy of my ESPP. Who knows? Maybe I need one of them to pay for insurance and taxes. One question I have for him is whether or not it really makes sense to put that single lump sum payment on the loan, or perhaps use it to beef up my cash reserves.

To top things off, I used the same calculator to find out where my second smallest rental mortgage would be in 2017, and calculated when it would pay off assuming I apply all the rent from the first unit. Answer: 2020! So, with extra rent added on a monthly basis minus one mortgage payment and throwing in a chunk of ESPP once-a-year, I can pay off the first loan in five years, and the second one three years after that. Estimating the 3rd and 4th units is probably absurd at this point, because there is too much variance that can happen in the next eight years. But I can only imagine that pointing the rent from four units with only two mortgage payments will be grand.

Circling back to the original topic at hand: you need to understand some fundamental concepts and when to use the right calculators. Plug numbers into a spreadsheet on an annual basis, and see how the balance of your loan drops based on paying the minimum vs. an increased monthly/annual/one-time amount. Also consider how you would get your hands on that cash down the road, and think about what you would do with the money at that stage. Buy more rentals? Stocks? Fund another EIUL?

Kicking around some ideas? Send me a message and I’ll be happy to discuss things with you.

Know anyone that has actually done buy-term-invest-the-difference?

wealth“But term and invest the difference” is a catch phrase idea that has been bouncing around for 10-20 years.

To do this, you must get a quote for cash value life insurance, like whole life or universal life. Then you get one for term life for the same amount of coverage. Buy the term policy and then start stuffing the difference into some mutual fund.

I have yet to meet anyone that has done all this. Many glorify the concept and are quick to bad mouth cash value life insurance. But ask them to show you a real illustration for both, and it seems everyone is empty handed.

Some have mocked the concept by calling it “buy term and spend the rest”. Probably because most spare money that isn’t forced into savings ends up getting spent on “stuff”.

Frankly I think the fallacy of this idea is how people don’t realize how much money is being suggested to be set aside. I admit I haven’t done this exercise myself. But that’s partly because I don’t believe it’s the right approach. I have a term life policy AND and over funded EIUL. My EIUL’s face value is about 1/3 the face value of my term policy so I deduce if I triple my EIUL premium, that would be my target amount.

And it would equal about 30% of my take home pay. Who wouldn’t do well setting aside 30%? The truth is, I can’t afford that much! And I doubt many out there can. Or at least, I doubt most would be willing to live such a lifestyle.

You might criticize me about not committing myself to the cause at hand or being unwilling to eat rice-and-beans. But the truth is, I don’t know to set aside such a huge amount of money to build a tasty amount of retirement wealth.

My father always told me, “work smarter, not harder.” –Scrooge McDuck

My real estate investments are doing well and they are realized by my willingness to set aside 15-18% in my earlier years. Part of the credit for that goes to my brother, who told me over the phone the week before I started, to max out my 401K.

VNR and my other stocks are doing well and paying me cash dividends. They are made possible by my willingness to take advantage of a HELOC.

Combine that with me slowly paying off a vacation home and stocking cash in my EIUL and I have no need to save 30%. And I also have mitigated away the downside risk of mutual funds.

Filing taxes is now in progress

TaxesI’ve mentioned before how complicated taxes can become as your wealth building plan gets underway. When you enter the workforce and start punching the clock every day, you have what’s known as ordinary income. That’s IRS-speak for job income.

But if you start adopting some of the practices I’ve mentioned, your income begins to change. I still get a majority of my income from my daytime job, but now I also receive rent, tax deferred MLP distributions, and qualified stock dividends. I also get paid a quarterly check for a book I wrote three years ago. I also had some other awkward sources of money.

One thing I had to dig up was how to handle the fact that I didn’t receive a 1099 INT from any of my banks. I knew I had received interest. It turns out that banks will usually only send you such a document if you earned over $10 in a given account. I didn’t make it. Nonetheless, Uncle Sam still expects you to report every penny so I simply looked up each account’s December 2013 statement and wrote down the year-to-date interest.

As a rule of thumb, I thought about every way that money came into my hands last year. It helped me remember a couple things that don’t come in the mail. I gathered a pile of electronic documents and emailed them to my CPA.

Last year, I had a tremendous tax bill. That was because I had to deal with the aftermath of nuking my 401K. While it was a hefty bill, the results were fantastic. I found a giant source of capital to create my real estate portfolio. Last year, I grossed over 50% of my daytime job in rental income. That’s a hint that things will be GREAT down the road. And need I mention that with a purposeful plan set up by Jeff Brown, ALL of that rental income is tax sheltered?

I’m eager to hear the feedback from my CPA. It’s pure speculation, but I’m guessing I’ll still be short and have to write a check to pay the difference against withheld taxes. But who knows? Thankfully this time, we won’t have to file an extension.

Happy tax season!

Buying a car with cash

toyota_highlanderI just recently bought a new car with cash. The feeling was great!

Let me fill in some details. My wife and I have been looking into another car for at least a year. We had looked at many models and had a list of features we wanted. We were also open to buying used, perhaps up to 2-3 years old, if it was in good shape and didn’t have gobs of mileage. But the key part of it was: it would be a 100% cash purchase.

Unfortunately (or fortunately), we couldn’t find anything used that didn’t have high mileage. It only cost a few thousand more to buy a 2014 new car with less than 200 miles than a used car with 70,000+ miles. (Some of these used cars, in fact, cost more than what we got). To top it, the features they include with the baseline model were WAY more than we needed. Given we have smart phones and our own DVD player, the upgrades were frankly unnecessary.

Car payments can really drag you down

Top priority: I didn’t want to take on a car payment. I’ve heard statistics say most cars you see driving down the road are dragging along a $400+ monthly car payment. If you’re reading my blog site, then I can bet you have already heard the pitch to save up and buy a car with cash instead of financing it with debt. I heartily agree with this practice.

The other piece of advice I often read but doesn’t seem to get stressed as much, is to try and make your car last a long time. Don’t get caught up with “car fever” and think about new one three years from now. That’s already burned into me. My wife’s car is eleven years old, and our minivan is seven.

Here’s some good news from the industry according to Kelley Blue Book,

“Americans are now holding onto their new vehicles for a record 71.4 months. On the used vehicle side, that interval has risen to 49.9 months, a figure that also represents a new high mark. Collectively, the ownership period currently stands at 57 months, up from about 38 months back in 2002.” — Kelly Blue Book, 2012

57 months equates to about five years. That’s good to hear! But better yet, if you can keep your car for ten years, you will be way ahead of the curve. Cars require a significant outlay of capital. The last car I bought was seven years ago, and I’m still driving it.

What if you can’t buy a car with cash?

I can certainly empathize with those that want to pay cash but simply can’t. I don’t want to get preachy. There are radio shows and forums that talk about how you CAN in fact buy a car all cash. You just have to lower your expectations, save, etc. Everyone reading this has probably heard all about it. I’m not hear to sway you in that regards.

What I want to write about is how my ability to pay all cash represented a more deep seated realization. My net worth and money making efforts have grown to the point that I CAN pay all cash for a car.

Given the current performance of my rental properties, EIUL and dividend paying stocks, I feel like the next time we buy a car, we will be even BETTER off than now.

I don’t have the data on hand to back this up, but I’m speculating that those that don’t have a solid wealth building plan in action probably tends to wards buying cars more often and using financing. Cars are nice and shiny. We all like to have them. I’ve driven through neighborhoods where things don’t look very wealthy, but people still seem able to have a couple nice, new cars. It’s probably the biggest “toy” people can buy and get it financed through the bank.

As my father told me the last time I went car shopping, “your goal is to beat the average.” That applies to building wealth, buying cars, and anything else money related.