So Where Exactly Should I Put My Money – Mutual Funds? Real Estate? A tech start-up company?
Well that’s a tricky question to answer, and it will certainly be different for everyone, but there are some key things that may help you answer that question for yourself. Even though this blog focuses primarily on real estate and technology, there are so many different avenues to build wealth and create a portfolio to “retire” in less than the 40 year grind that has more or less become the standard for previous generations. It actually boils down to some pretty easy math assuming you can keep a budget! This has been discussed multiple times on other personal finance and financial independence blogs, but I just want to reiterate how powerful compounding is, especially the sooner you start investing.
The math for achieving financial freedom comes down to having more passive income than your expenses. That’s really all it takes! Now the path to get there is a little tougher to define so easily, but there are so many different options and possibilities to do so. Without even considering real estate for a moment, you could potentially retire in 15 years by just taking advantage of standard retirement accounts offered by many brokerages, most of which are sponsored by employers. I’m talking about 401k and IRA plans. How did I get 15 years? Well lets break it down!
Lets assume your average expenses for a year are $25,000. This includes everything, your mortgage/rent, car payments, gas, groceries, vacation, fun money, you name it. Now in order to perpetually be able to spend that $25,000 year after year, you would need a large sum of money in an account that is growing in the stock market that pays dividends. How much money? If we take the $25,000 and divide it by a fairly conservative 6% return in the stock market, then we would need exactly $416,666 in order to cover all expenses year over year. Pretty neat eh?
Now this previous example has a lot of assumptions of the type of fund you’re investing in and the potential fees associated with it, but the general math is what matters. If you are able to sock away enough money into a 401k and IRA every year that is returning 6% on average over 15 years, you’ll be able to sit back and let the dividends roll in to cover your basic needs! This isn’t even considering the power of real estate! We’ll get into that next.
Contributing to retirement accounts without employer sponsored plans is still certainly a good thing to do, however there may not be such strong incentives like matching or other profit sharing benefits. In this case, you may be self employed or your company simply does not offer the greatest benefits. And that’s ok! Then we start to look at other viable options for investing our money.
Why Real Estate?
I dove into real estate back in high school when I would love coming home off the bus to look at huge properties online and wondering how I could actually buy these houses. Then I found the real estate investing community on Biggerpockets and never looked back. Real estate can be so much more powerful than traditional retirement savings if you understand how the math works and can stomach the higher risk.
Lets do another example, but this time with a rental property. Lets say you still have $25,000 in expenses every year like our last example. Instead of contributing to your retirement accounts, you buy a property for $135,000. Lets assume this property is in fairly good shape and doesn’t need much to rent it out. If you purchase this property with a 15% down investment loan and then rent it out at $1650 per month, you’re looking at a 25% return on your money invested over 30 years. Those are pretty good returns right? Now, there are quite a few caveats to this and not all markets can sustain this kind of deal, but they are definitely out there. Buy 5 of these type of deals and you’ll reach that $25,000 per year in income to cover expenses, and with a fraction put up front than the $416,666 that was required in the 401ks and IRAs! We’re able to do this because of leverage and using other people’s money (OPM). In this case the other person is the bank that is handing you a loan for 85% of the value of the house while giving you the ability to use it as an income stream.
Now this all sounds great, but I just want to mention that being a landlord, house flipper, or other type of real estate investor is in no way similar to just throwing money into the stock market and sitting back to watch your gains roll in. When first starting out, it will seem like a full time job, and it essentially is. The learning curve can be tough to overcome and there will be situations that will make you never want to buy a house again if you are not prepared. If you’re willing to put in the effort though, the higher reward is out there.
Asset Allocation
Whichever asset class you decide to park your money, there is one thing that you should always keep in mind – Asset Allocation. Asset allocation is basically a how much of a certain asset class you hold as a percentage of you overall total portfolio. So if all of the assets you own is valued at $1,000,000, and your real estate holdings are valued at $550,000, the we can say that your total allocation of real estate in your portfolio is 55%. Everyone has their own risk tolerance for how much of each asset class/type they hold in their portfolio. Some people might be comfortable with the 55% of real estate, and others might feel comfortable with 95%, it all depends. How you determine these percentages for yourself at any given moment is a culmination of so many variables, and they will change over time. A general rule of thumb for younger individuals is to allocate wealth towards more risky investments, and if you’re older, focus on more conservative investments like bonds or established conglomerates. The thinking is that if you’re younger, you have so much time ahead of you that if you fail, you can still make up for the losses.
Here’s a breakdown of what an asset allocation might look like for a 26 year old corporate professional, Lets call him Jeff:
| Asset Class | % of Portfolio | Asset Value |
|---|---|---|
| Real Estate | 65% | $487,500 |
| Stocks | 15% | $112,500 |
| Bonds | 5% | $37,500 |
| Commodities (Gold, Silver) | 5% | $37,500 |
| Cryptocurrency | 2% | $15,000 |
| Cash | 8% | $60,000 |
| Totals | 100% | $750,000 |
We can see that Jeff has real estate tipping the scale quite heavily, and that might be just fine for him! Jeff also has some stocks and bonds which is a good hedge against any issues that may arise with the real estate holdings. He also has a good chunk of change on hand as cash in the bank for a rainy day.
Grab Your Checkbook by the Horns
Take a step back and really understand where your money is. Do you feel you have too much allocated to a certain thing? Maybe you need to adjust your budget throughout the year to reduce expenses and focus more on investing in a certain area? Grabbing hold of your finances is essential to developing a roadmap for your future investing goals. Even if you feel you’re spending way more than you thought, that might be OK! Just make you’re aware of it and it’s providing value to your life in a healthy way. There are numerous resources out there for financial independence and how to cut expenses to ultimately “retire” early. Here are a few that have helped me in the past:
Each of them have their own perspectives on what’s important for your finances, so make sure you take everything with a grain of salt and adjust it to fit your lifestyle. Real estate has taught me that there are always super creative ways to build wealth, so I encourage you to check out the links and find your roadmap for saving more money and building your own wealth