So, it seems that creating a mix of bonds and stocks and then picking some magic withdrawal rate (e.g. 4%) is not the ideal way to plan our retirement (a.k.a. life after work) after all …
… instead, it seems that we need to create our own Perpetual Money Machine: a renewable resource of cash 😉
The ideal Perpetual Money Machine – at least, according to my liking – is Real-Estate (more wealthy people build their own Perpetual Money Machines using real-estate that any other investment, even more so than cash, CD’s, bonds, mutual funds, or stocks):
1. Real-Estate (particularly commercial real-estate, when purchased well) protects your capital and keeps pace with inflation; it will last as long as you do, and then some!
2. Real-Estate (when managed well -and, this is something that you CAN confidently outsource) protects your income (i.e. net rents; they will grow with inflation).
3. The bumps in your real-estate road can be managed with insurance and provisions: you can insure against most catastrophic losses (and, you can spead your RE investments to minimize even those risks), and you can keep a % of your rents (and, starting capital) aside to help smooth your income stream (against vacancies, repairs and maintenance, etc.).
For example, with $7 million (aiming for a $350k per year gross income – indexed for inflation – which should net $200k – $250k after tax), you could:
1. Keep $500,000 as a two years of living expenses cash buffer (one year to allow for the rents to start coming in, another year “just in case”),
2. Invest $6.5 million CASH into 5 x $1.0 million to $1.25 million dollar properties (allowing for closing costs, etc.),
3. Which should provide 5 x 7.5% x $1.0 million to $1.25 million = $400,000 gross rental income
4. Of which you would pay tax of 30% (say) and divert another 25% of the remainder to your ’emergency / provision fund’ leaving $215k (PLUS, tax benefits such as depreciation, tax deductions of cars, certain travel and other business expenses etc.).
After every few ‘good years’, you can trim your provision fund back to two years of living expenses, allowing you to buy some more real-estate (therefore, providing the basis for another future pay rise!).
If you don’t like real-estate, then you can always lower your spending expectations and dust off your bond-laddering books 🙂
I’m also a fan of real estate as a long term investment vehicle – it tends to be a stable generator of cash flow. The ability to leverage at cheap rates with little prospect of the bank calling the loan is also a major plus. Real estate makes up the majority of our investments.
However, it does have some disadvantages:
1. it’s not liquid. Selling (or borrowing more money) takes time compared to selling equities or mutual funds
2. transaction costs are high – much higher than equities etc
3. if all your real estate is in one sector in one city, you will have only limited diversification (if you spread out geographically, you may have management issues)
4. equities are more tax efficient (at least for me in HK – you milage may vary on this one)
5. it takes more time to manage than unit trusts etc (but probably no more than individual equities)
My intention is to have the majority of our assets in real estate, a chunk in equities for diversification and liquidity purposes and enough in cash or cash equivalents to cover two years of expenses. I have very little interest in bonds.
@ Trainee – I, too, have equities, but certainly not for “liquity purposes” 🙂
Real estate is a great investment, as long as you buy at a good price and you’re okay with being a landlord. Of course, being a landlord can start seeming as much like having a job as it does like having an investment.
You can hire someone else to do the work of being a landlord, but then you have to expect your return to drop to something much closer to what you can get on other passive investments.
I agree with real estate as the ideal investment, if done properly. This has been reinforced by personal experience and the summation of everything I have read thus far.
@Philip, I understand what you are saying about being a landlord, but I really relate being a landlord to amatuer investing, not perpetual money machine investing. As you step up to multi-units (where I would consider one “crossing over”) self management is imprudent, unless you start your own management company. As a sidenote, I truly respect your opinion, and consider your articles quite insightful and intelligent (Adrian being one of the only other writers I put in this category).
The reason I prefer RE to equities for investment is that I can control the outcome and return more so than the profitability of Ford or the S&P index.
As with everything, it all depends on the individual, I would not recommend what I do to my friends or my mother. Most people won’t do the homework to invest prudently (in equities/RE/etc)
I go back and forth on the investment property issue, and I am happy it has worked out for AJC, but I have watched my dad deal with C R A P for years. He owns 2 properties:
1) CASH COW – 2 family residential unit income exceeds mortgage payments. They always pay on time and there mostly are no problems
2) 2 family unit with a bar attached. I have listened to him say for YEARS, that if the bar paid its rent things would be different. I feel like the stress associated with this property is going to kill him eventually, and that is the commercial part.
In NY it takes 9 to 18 months to get someone out, so even if you try to evict you are looking at legal and time costs that could literally eat 6 months profit.
I’m still a little afraid of RE and have been tenaciously holding stocks picked according to “Rule 1”. Things are looking up after being flat for a long time. There just may be something to value investing? The question for me becomes where/when to place stops.
I think the chances of success may be higher for real estate than for stock picking — unless you’re a market maker, lender, fund manager, brokerage, etc., i.e. “the house”. That’s not to say that there aren’t those that win without being on the house side of the equation, it just means a little more work, maybe? We’ll see.
@ Philip – We don’t need capital appreciation, as we have already reached our Number. Just keeping up with inflation (esp. our rents) would be plenty!
@ Evan – That’s why we keep TWO YEARS’ buffer 😉
@ Ill Liquidity – Our strategy would be very different if we were still working towards retirement (a.ka. Life After Work). Value stocks (along with businesses and RE) would be one of my favorite MM201 (wealth acceleration) strategies.
For those who have stated that they are a little afraid of RE. I think your fear lies more to getting a return from your investment. I.E. Becoming underwater on your Mortgage, or not getting your money back ,if and when you sell.When you think about R.E., your not making your money at the sale. You actually make your money when you buy. If you buy at attractive prices, you should have no trouble making money during ownership and even at sale.
Stocks on the other hand, you can do your due diligence,and still be wrong on the prices,and perhaps lose a bit of money. But, your not going to make money on every stock purchase and sale. No one does. Just keep stop losses in place, have a reason for making the purchase and a reason for getting out.Don’t let emotions get in the way, and you should do well.
@ Steve – True; but, for MM301 at least, [within reason] we do not even need to worry about buying ‘well’ as we are never planning on selling …
… of course, the less we pay for a given property, the greater our return a.k.a. withdrawal rate / retirement income 😉
Adrian, if you don’t buy well, you may not be cash flow positive. Its best to know your market so you don’t over pay for the property ,even if not planning to one day sell.Just makes sense (I believe anyway).
Of course, if you want a real perpetual money machine, 40 years as a civil servant will get you a bloated COLA’d pension at taxpayer expense.
@trainee – That was my original plan… before realizing that public assets can be sold off and pension funds mismanaged.
@ Steve – You are 100% right … I was often ‘paralysed by analysis’ in trying to ‘buy right’ for MM201, but realized that I don’t need to be quite so paranoid about buying good MM301 property (it’s very easy to produce postive cashflow when you pay 50% to 100% cash; albeit, within the property selection bounds that I will recommend in a follow-up post, soon to come).
Investment property is a solid way to build wealth, but it does not come without some serous skill sets. From money management too dealing with tenants, one could use a management company to handle the day-to-day operations, but this cuts into the profit margins. But the price point that you pay for the property I would say will determine how the investment will play out over time.
I don’t understand everyone’s dislike for having an outsider run your Real Estate for you. First off, your not going to want to do it yourself in retirement,second management companies are not all expensive.Some are ,yes,but not all. Your going to chose these people(hopefully) as well as you chose your Real Estate in the first place.
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