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!

Add to: | blinklist | del.cio.us | digg | yahoo! | furl | rawsugar | shadows | netvouz

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?

If so, strap in, because I am about to devolve the myth of income by looking at two case studies, both from Networth IQ a web-site for people to track (and discuss) their own Net Worth.

To start, here is an excerpt from an e-mail that I received from docsd  (you may need to register and log-in to see his Networth IQ Profile):

I have been awaiting approval on a home that I am purchasing and just received word today that I was approved for the loan and that the closing process will proceed. My wife and I plan on staying in the home for many years to come, as it is an older historic horse farm on several acres outside of Louisville, KY and this home fulfills my wife’s dreams of being able to have horses. I actually came to a compromise with her regarding this house because my goal has always been to live as far below my means as possible while accumulating wealth and her goal was to have a considerable and high-end horse estate on several acres (obviously not inexpensive living, especially if this is a 500k-million dollar home that you plan on staying in). The compromise we made was to wait as long as we could to find the best deal possible so that we can fulfill both of our desires between the property and the low personal overhead to help with wealth accumulation. That time has come and we found the property, basically stole it for tens of thousands below its most recent appraisal and we qualified to purchase it while still holding on to our current home. We are purchasing the new home for 325k and our current home is valued at between 307k and 314k.

I feel I am in a unique position as the owner of 2 homes this early in starting my career and have a feeling I can make a much better situation out of my current home by holding on to it instead of selling it quickly in this market….however, I am worried that it is too pricey to be able use as a rental property investment at this time. Provided I refinance it to the going rate, around 6%, which is considerably better than the 8% we qualified for when we bought it just over 2 years ago, the total monthly liability for us would be just over 2k per month and I’m just not confident we can get that much monthly for rent here at the moment. This house is a very nice and large house in one of the more exclusive parts of town (in an area that has been averaging nearly 10% appreciation for homes per year across several years and not impacted near

What would you do if you were the ‘Doc’?

Obviously, we don’t know nearly enough about his situation … and, we can’t give specific financial advice, anyway … but, we can make some general observations:

Firstly, we can see a hard working professional (we presume) earning over $150k per year … easy street!

Then we see the problems that go along with it: too much house, too much lifestyle, too much debt … even though our ‘Doc’ says that he is focused on saving and wealth creation.

But, Doc has some bigger issues to deal with:

1. Student debt and other debt (plus his mortgage) of nearly $160k that must be paid off!

The ONLY reason not to concentrate solely on paying it off now is if (a) the interest rates on these loans are lower than mortgage rates, and (b) the money that should be used for paying off these loans will instead go into long-term, buy-and-hold, income producing rental property.

2. The ‘doc’ has a negative Net Worth!

Now, that’s always understandable for a professional with large student loans to pay off early in their career; I don’t know how long ‘our doc’ has been working, but to be looking to compound this Net Worth deficit by upgrading lifestyle is not something that I would usually recommend.

But, there is also an emotional/lifestyle decision to be made here: 

For example, we need a wife who is onside, so it would be tempting to simply swap one home for the other (keeping in mind it’s probably ‘only’ a $50k – $100k ‘swap’ … new house is slightly more expensive than the existing, but there will also be closing costs and selling costs, etc.).

But, I have a question around the horses … this house comes with a new lifestyle: are the horses just an expense (i.e. buy, feed, maintain) or also an income (e.g. agisting other people’s horses, selling horses, giving riding lessons, etc.)?

If the latter, I would consider upgrading just to keep the ‘little missus’ happy, but only if I was committed to earning more and using that extra income to accelerate debt repayment … if the former … hmmmm.

Given that we are not really assessing the Doc’s situation, because we don’t know enough, we need to realize that high income = high wealth only when that income is put to:

a. Debt reduction, then

b. Passive Investments

Lifestyle comes from the perpetually sustainable income that good passive investments should spin off … at least, that’s how I live.

In Part II, we’ll look at the super-high-flying-sales-rep …

Add to: | blinklist | del.cio.us | digg | yahoo! | furl | rawsugar | shadows | netvouz