No, we are not talking about the effect of prune juice of the vital bits of our digestive system!

We are talking about beginning to wind up our Perpetual Money Machine (believe it or not, the above ‘prune bush-driven machine’ achieves both objectives!?) …

… the one that we are designing for Scott who is earning a great passive-seeming income (but, not really because it comes as royalties from various movies and inventions that Scott has created over time, not actually from cash in the bank or the equivalent).

Scott already understands this:

Have some in real estate, but not much. What is your take on the time it takes to start realizing a “substantial” income from real estate?

Longer than you think, Scott 🙂

The problem is that RE has a ‘lag’ time that is hard to estimate: you need to cover closing costs, rehab costs, tenancy costs just to ‘wind the property up’ … and, it’s possible (likely) that you will need to wait X years until inflationary forces push rents up higher than your (hopefully, fixed) mortgage costs (plus the costs of maintenance, vacancies, property taxes, etc.).

Of course, on the PLUS side you have depreciation allowances and tax benefits that can produce paper-profits, but these take very careful management to live off 😉

It’s why building a real-estate portfolio, while you can still seed it with income, is better than waiting until you can cash out (i.e. retire and cash out your 401k; sell your business; discount your annuity/royalty incomes by selling these) … you may find that you become ‘asset rich and cash poor’ for a while.

There has been many a successful business owner who has sold their business only to suddenly become ‘poor’ by putting all of their nest-egg into newly acquired RE  …

… but, that won’t be you, Scott, because you are building your Perpetual Money Machine while you still have increasing incomes.

In fact, this is the key!

You still keep ‘seeding’ your RE portfolio with the same/growing 15%++ of your income until you no longer need to cover the negative cash flows from the current ‘income capacitor’ (i.e. property/s) and have saved enough as a deposit (plus buffer for contingencies) for your next one/s.

You repeat this process until you have too many capacitors/properties to manage, in which case you trade up through a series of 1031 Exchanges until you have a manageable portfolio, and …
Final installment of this series of posts on Friday …

And, if that’s what you want to do, Caprica conveniently points us to Tim Ferris’ goal-setting process:

Tim Ferris, in his interesting book called the “Four Hour Workweek” – although, I can’t figure why anybody would want to work that much 😉 – introduces an interesting exercise called ‘Dreamlining’; he says:

Create two timelines–6 months and 12 months—and list up to 5 things you dream of having (including, but not limited to, material wants: house, car, clothing, etc.), being (be a great cook, be fluent in Chinese, etc.), and doing (visiting Thailand, tracing your roots overseas, racing ostriches, etc.) in that order. If you have difficulty identifying what you want in some categories, as most will, consider what you hate or fear in each and write down the opposite. Do not limit yourself, and do not concern yourself with how these things will be accomplished…This is an exercise in reversing repression.

Now, Tim’s worksheets are great, but when you write your Rear Deck Speech properly (from my 7 Millionaires … In Training! ‘grand experiment’), you will find that it encapsulates the true ‘being goals’ that Tim talks about, and it does it in a really powerful way: by ‘forcing’ you to look back on your life after it is (almost) done.

If you really think deeply about this, the most important aspects of your life are all about ‘being’, not ‘having’, a least not in a purely materialistic sense …

As to the ‘having’ goals, they are important too, and this process and worksheet should help you to think through this.

Here is the way that I think about it:

To start any journey, you need a Destination and then you need to decide when you intend to get there and choose your mode of transport accordingly. You also need to ensure that you have enough money to buy the gas or tickets.

Financially speaking, your ‘destination’ – or the only one that really counts – is your Life’s Purpose … it’s your final stop, after all!

But, the real purpose of this exercise, from a financial perspective, is that it helps you to find you Number (the ‘fuel’ that you need to get there), your Date ( the ‘when’ you want to be ‘financially free’), and the method that you will use to get there (saving, business, investing – real estate, stocks, options, etc.).

Now, some people then like to sit down with a map and travel guide and plan every stop and way-point along the road (a.k.a. ‘intermediate goal-setting’) … for others just traveling the road and taking whatever stops that seem interesting/necessary along the way is good enough.

So, if you then want to do some serious goal-setting of the MoneyMonk kind, don’t let me stop you … it’s probably a very good thing to do!

… but, whenever I try that, I am always painfully aware of how difficult life is to plan.

Who was it who first said: “When Man plans, God laughs?”

This video was sent in to me by Jason, and is an annotated version of a Spongebob episode that I have seen before [AJC: Hey, I’ve got children …. besides, I like cartoons 🙂 ].

The video will teach you how (and how not) to sell!

http://www.icanlearnanything.com/video/?id=184

I’m still receiving questions and comments regarding this post: Will you ever put a penny in your 401k again?

Jeff said:

I can see how some people couldn’t stomach the additional risk of Real Estate investing…and thus the decision to get a company match in a 401K is an easy (near automatic) choice. For me, I want to determine a return that is reasonable for each option, and then compare it to the associated risk before I make a choice.

There are two wrong ways to look at this whole question, and one right way.

First the wrong ways:

1. Shouldn’t I invest in the 401k to get the tax benefits and the employer match?

2. What do I do if the choice between the 401k and the other choices that I’ve been looking at seem close?

You see, the first question aims at maximizing company benefit, and the second aims at maximizing investment returns. These are not the same thing … and neither are they the thing!

The one and only question that you need to answer is:

3. What do I need to do in order to get to my Number?

If you don’t know your destination, any road will do …

… but, once you do have your destination clearly in mind, typically only one road (and, you may have to look hard to find it) will usually jump right out at you!

For one person it may be that the save-and-forget 401k option is right, but for another only a more active form of investment will get their to their Number.

The rule of thumb: the longer the time frame that you have available, and the smaller your Number (say $2 million in 20 years) the more likely it is that the 401k + own-your-own home + remain-dent-free strategies will work for you.

But if your Number is larger/soon (say, $5 million in 10 years) then you have to do something more or you simply won’t make it …

___________________________________________________________

Special Announcement: Who did I select as my 7 Millionaires … In Training!?

Click here to find out!

___________________________________________________________

Recently, I pointed you to some typical personal budget allocations at varying income levels i.e. $100,000 p.a.; $250,000 p.a.; and $550,000 p.a. (before tax).

So, I was very interested when I happened upon this chart from Crown Financial Ministries, a Christian organization that helps people with their personal budgets and debt reduction strategies. This chart illustrates their concept of an ‘ideal’ personal budget allocation.

I should point out:

1. This ‘budget’ is after-tax (assume 35% tax rate)

2. Being a religious organization, it (naturally) also assumes tithing (I presume it’s 10% of gross)

3. You can be sure that it represents low-to-average salary levels – given its target audience – so you may want to combine this with other estimates (such as the ones above) for higher income levels.

For most personal finance bloggers this is a way to assess your current budget so that you can make sure that you reign in your spending and save every last dollar.

While this is wise and honorable, I provide these numbers for a totally different purpose: so that you can assess your future budget. This is the budget that you would like to have when you retire.

Use these resources to try and put together the lifestyle that you want to live when you retire – as though you were living it today.

Once you have your Required Annual Expenditure firmly in mind, you will need to account for the inflation that will occur between now and when you do stop work …

… for example, if you think that inflation will only be 4% and you intend to retire in 20 years, you will need to double the income that you anticipated (for 10 years add 50%, and so on).

How will you fund that if you have retired?

By having at least 20 times that saved up on or before the day that you stop work, is how!

Special Announcement: After 4 months of ‘try outs’, the Final 7 Millionaires … In Training! will be announced this Thursday on my Live Show this Thursday @ 8pm CST (9pm EST / 6pm PST) at http://ajcfeed.com ….

__________________________

I wrote a series of posts about a hypothetical ‘battle’ between the Mighty 401k and Humble Real-Estate. For those with a sharp eye, I posed the original post as a question, not a recommendation.

However, it is my contention that, for many people, the 401k will lose when compared to many other forms of active investment – including, but not just real-estate!

For those of you who read this highly contentious post – and, the follow-up posts (which you can find by following the ‘track-back’ links listed at the bottom of the original post) – you will, hopefully, realize by now that my point was simply this:

Don’t blindly follow the pack by simply plonking your money into your 401k to get the ‘free money’ employer match and tax-benefits!

Do your homework first … there may be better investment options out there, for you.

The example that I used was comparing the 401k to investing in 4 or 5 single-family homes as rentals; Pinyo said that he ran the numbers and the 401k ‘won’ (but, he didn’t provide any further details) and Jeff says that he ran the numbers are found it to be a close call – you always know that you’re in trouble when somebody begins with “I appreciate your attempt …” 😉

Anyhow, here’s Jeff’s comments:

I appreciate your attempt at explaining why Real Estate investing should at least be considered over equity investing in an employer-matched 401K. I ran the numbers using your assumptions (adding in tax consequences–property and income–and cost of property insurance) and, although the annualized return was much closer, your Real Estate investing scenerios came out slightly ahead. I expected this result as investment property investing usually carries increased risk (and hand holding) and thus should provide increased reward.

In going through the process of comparing investment options, I was suprised by a few things. 1) the Real Estate investment option, according to your scernio, suffered from 8-15 years of undiscussed or accounted for negative cash flows after costs, such as property tax, insurance, mortgage payments, and your 25% unrealized income either due to maintenance or unoccupancy, and 2), more importantly, the overall outcome (equity v. real estate) varied drastically based on 2 assumptions: estimated appreciation of real estate over 30 years and estimated return in the equities market over 30 years. Even a 1% point swing in either of these assumptions made a huge difference in projected outcome, i.e., which investment option was better.

I looked through your blog (not exhaustively) for a post discussing your reasoning behind these 2 estimates, but failed to find one. Since it seems that the accuracy of these estimates (best and worst cases scenerios over 30 years) is essential in determining if either investment option has a clear advantage, I was hoping you could either point me to a post of yours discussing them, or let me know of any books, articles, etc, that led you to your estimates.

As I said to Jeff, the mere fact that it is at least a close call means that it is no longer sensible to just automatically plonk your money into a 401k just to get the employer match.

Surely, your goal isn’t to gain ‘free money’ and/or tax benefits …

… it’s to end up with a sh*tload of money, right?!

You can only do that if you investigate all the options available to you. By that, I mean all the options that interest you!

For me, that’s stocks (but not mutual funds); real-estate (but not single-family homes); gold/silver (but not other commodities); etc.

For most people, it will simply mean putting up the 401k scenario against one or two other choices, just as I did in the original post with real-estate.

With all the online calculators available out there, it’s not hard to do a rough analysis, using the 401k option – with numbers that make sense to you – as your baseline.

If, as Jeff found, it turns out to be a close call, then stick with the 401k … it’s simple and at least gives the appearance of being low-risk.

For me, though, if it’s a close call I usually choose the most ‘active’ form of investment as I know that I haven’t factored in all the upside potential.

But, to answer Jeff’s questions; it all boils down to your estimates – or at least appears to:

Now, while I used 8% as the return from the 401k to allow for the very-slight-risk (even over 30 years) that you will pick the worst market time to start investing, you will find that the typical index fund will return upwards of 11% over 30 years minus costs (index fund costs; sales commissions; employer admin; etc; etc.).

This all depends upon your 401k and the options that your employer allows – a reasonable rule-of-thumb is to allow 1.5% for costs. So you could rerun the numbers at 9.5% returns.

Now, what company match will you assume? I allowed 100%.

However, will your employer give you 100% match now and for the next 30 years (since, you’ll likely change jobs 4 times in 30 years)? Think very carefully before answering this question!

You will also find that your contributions are maxed to $15k or so a year, which kind of makes this analysis moot, because any serious investor will be wandering what to do with the rest of the money that they want to invest.

On the real-estate side, according to Todd Ballenger author of the new book Borrow Smart, Retire Rich “since 1945, the median house price in the United States has risen by an average of 6.23% per year”. Others will quote studies saying that single family homes only keep pace with inflation (currently 4% – 5%).

So, I selected 6%, which I feel is a little low, and allowed 5.25% for a fixed mortgage (which, now, is also a little low), and 5% rental return (which will start to become a little low again), and 25% of all other costs (incl. insurance, property taxes, R&M, etc.) which could be high or low.

Again, run the numbers and if it’s a close call, don’t bother with the investment option.; stick with the set-it-an-forget-it 401k.

But, let me pose a small question: does investing either way do it for you?

Does it make your Number?

If either way does (and, in the time frame that you want to get there), don’t sweat it … again, go for the 401k and relax.

Life wasn’t meant to be that difficult 🙂

But, if it does not ‘do it for you’, hang tight, I have more for you soon …