In Devolving the Myth of Income … Part I we explored the following question: “what’s your definition of ‘rich’ … would being a highly-paid professional (such as a doctor) or a high-flying executive (such as a high-tech sales rep) earning megabucks-per-year do it for you?”
Today, I want to finish exploring this subject by looking at question recently posed on Networth IQ a web-site for people to track (and discuss) their own Net Worth.
The question was posted by mario (you may need to register and log-in to see his Networth IQ Profile):
Like many Americans, I have a great deal of equity in my home, built up by “trading up” over the past 20 years. At this point I have over $2M of equity in my home, which represents two-thirds of my overall net worth. While this is all good, I am starting to feel like this flies in the face of my diversification goals; how can I consider myself diversified if I have 66% of my net worth tied up in one piece of real estate? I would sell the house in a minute except for the tax consequences. Does anyone have a strategy other than selling?
Here is a guy with a high-flying sales career, earning more than $250,000 a year and he’s less than 50!
He also has a house worth $2,000,000 …
…. now, you could be describing me!
But, there’s only two differences:
1. If I choose to stay in bed tomorrow … that’s OK. Stay in bed the next day … fine. The day after, the day after … it doesn’t matter. Even if I never bother getting out of bed again … the money keeps rolling in.
2. I can afford my $2 Million house, my Maserati and my $250,000 a year lifestyle!
Let me explain …
In a recent post I wrote about the Fisherman and the Investment Banker; ‘Mario’ is the Fisherman, I am the Investment Banker … what happens when Mario’s ‘fishing career’ stops?
When Mario stops, his income stops, and he can no longer afford his lifestyle. This is mainly because, Mario’s Investment Net Worth is much lower than his Notional Net Worth.
Here is what the Mario’s of this world – that is, those with high-flying corporate jobs and those in high-income-producing businesses (and there are plenty of both!) – need to do to ‘bullet proof’ their lifestyle:
1. Stay in the habit of saving – maintain the same good savings and debt control habits and (relatively) low-cost lifestyle as I hope you had when you were starting out, because you will need these habits when the income eventually stops flowing in … that will happen when you retire but it may happen even sooner than you think.
2. Only buy as much house as you can afford – obey the 20% Rule and make sure that you only carry enough mortgage that you can afford without compromising you savings and investing goals.
3. Revalue your house every 3 to 5 years – whenever your equity exceeds 20% of your Net Worth (Mario!), refinance the house and put 100% of that money towards your Investment Plan.
4. Accelerate your Savings Plan– save at least 50% of non-reinvested business income, every future pay increase, bonus, tax refund check, found money (the loose change in your pockets, Aunt May’s inheritance, that lottery win … anything and everything!). Enjoy the other 50% … go ahead … you worked for it!
5. Implement your Investment Plan – Every time that your Savings Plan builds up sufficient funds, add to your investments by buying and holding for ever any mix of the following that suits your skills and interests (do NOT trade with this money … build up a separate ‘spec fund’ if you want to do that):
a) Income-producing real estate, and/or
b) 4 or 5 direct stocks in companies that you understand and would love to own, and/or
c) Low cost, broad-based Index Funds.
I prefer investing in exactly this order, simply because you can leverage (i.e. borrow more) and improve returns by selecting/managing carefully (a) over (b) over (c) … but, that’s personal choice.
This simply boils down to saving more and spending less (now) to live well and securely (later) … no matter what you income is today … delayed gratification in action!
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I enjoyed the story about the Fisherman and the Investment banker. That’s the difference between think small and think big. Instant gratification (go home and play card with friends and family) or delayed gratification (work your butt off, then have the money worked for you so you can have fun).
I am already do #1, Since I have very little expense and debt-free, I am saving about 30% to 40% of my paycheck, and 100% of my part time gig. I’m thinking about investing in rental properties so that is inline with #2,#3, #5. Buying Condo (100k range) with sizable down payment (40%) and the rest is free as the rental money covers the mortgage and generate positive cash flow. Every year I should be able to get one condo from my savings. Keep doing this is 10 years and my passive income would be decent for me to live off. This is my really passive 10-year plan (except for the part of finding the property). What puzzles me is that lots of professional Americans are making good money, and why they don’t see rental properties that way — otherwise there will be more rentals than tenants! Man, If I see one thing works, I will replicate it 10 times or more.
I am still working on my start-up web businesses and I look forward to the day they can generate enough income. I will be as happy as a clam.
Every time I read your blog, I feel the strong message of “smart investing” and I feel a lot better because I make the right decision of delayed gratification. Thank you.
@ Alex – that is the slow-but-sure way to do it …
BTW: if you are prepared to take a little more risk, you could buy more than one rental @ 20% down and lock in current interest rates for as looong as possible (using two different lenders and telling them both that you are living in the condos so that you can lock in 35 years fixed mortgages would be unethical) … but, I’m not recommending this strategy, just showing our readers how one can take a low(er) or high(er) risk/reward approach to any investment strategy.
Great blog you have here! I love the concepts, and they make perfect sense.
Can you talk more about Investment Plan option a (investing in real estate). What strategy do you use for that? The Rich Dad, Poor Dad strategy (positive cash flow), or do you accept negative cash flow for a while. Do you try to put as little money down as possible, or as much as possible to have added safety (I’m assuming as little, to take advantage of leverage, but thought I’d ask).
Savings Plan: How much would you dedicate to this? I will start my job after my MBA this summer, and if I maintain my student lifestyle (which I want to do), I will be able to save around 30k.
How would you split that up between savings and investments?
Thanks for taking the time to write this blog.
Bravo! This is a great post…..very succinct and right on the money. It should be required reading for anyone serious about saving and wealth acquisition. I wish I head read and understood this ten years ago. I now only have to follow this the next ten years!
Thanks for your great blog.
@ Thomas – I am not a believer in ‘one trick ponies’ when it comes to investing … I will cover lots of: Uncommon Wisdom, How To’s, and Rules of Thumb as this blog runs its course, but the bottom line is that YOU will need to do what YOU are comfortable with.
First rule: save until you have enough to invest … then invest it all and repeat!
@ Tim – Thanks for your comments … I wish that I had this information 10 years ago, too!! … that’s why I’m writing it for you 🙂
It would help if you provided the link to previous entrys for those that didn’t read them.
@ Rob – now, I understand it’s “Rob IN Madrid” not “Robin Madrid” … sry 🙂 BTW: we loved Madrid; you’re v. lucky if you live there.
Aaah, I see … I linked everything BUT the main one … ooops. Fixed!
My questions is, if my income is roughly $1,000,000 to $2,000,000 a year and I have no debt other than two small car loans. How much house can I afford?
@ Donovan – I like your question so much that I will devote an entire post (3 to 4 weeks time) to answering it, because super-high-income can be a curse – not the blessing that the rest of the world imagines it to be.
In the meantime, keep in mind that the ‘rule’ on what you can spend on a house is governed primarily by your Net Worth – not by your income:
I have just read an artile that is relevant to an artile you wrote a while back.
This artilce concerns the topic of diversifying in your portfolio.
You made it clear that you feel diversifying is not the best choice, unless of course , you wish to do just average and maybe not retire rich.
Please read this article and give myself and the others here, your view about what you read here. I find it fascinating to say the least.
I don’t purport that he is write in his article but would really love to hear your views on the story…
@ Steve – You mean the article that promotes a method of investing that returns “a little over 8.68% annually … while not earth shattering by any means, compare[s] very favorably with the market’s performance over the same period. From July 1988 to now, the S&P 500 has advanced … around 7.86% annually.”
Am I missing something here, Steve?
well, what i liked about it is the dividend paying stock situation. certainly i wouldn’t consider as an only avenue to wealth, but do you feel dividend paying stocks are a better choice than non dividend paying stocks?
It would be a part of a total package i think . Something in stocks, something in real estate, and of course buying or starting a business that can generate a substantial income .
The article talks about many stocks. some did well while others did less than stellar, so if chosen properly, you should be able to expect somewhere near 10 % a year i would think.
@ Steve – I’m so glad that you wrote this comment as I’ve been itching to write a post about the fallacy of dividend paying stocks … look out for it in the next few weeks!