Are you making a financial faux pas.
As I was writing my “Investment Advice for 20 Somethings”, I felt like it would be very short-sighted of me to not discuss what you can do once you have got yourself covered on the financial basics. Even if you are 30 something, you may still be making the financial faux pas that many 20 somethings are susceptible to. I highly recommend looking at the 20 something investment advice before considering what I share with you below.
Now that you have enjoyed your 20’s and are finding some financial stability, it is time to start thinking about larger, long-term investments. And no, I am not talking about the stock market where you set it and forget it or roll the dice and try to become a day trader (unless that is your profession of course). I am talking about collateralized investments that are not dictated by the volatility of the markets.
“Now that you have enjoyed your 20’s and are finding some financial stability, it is time to start thinking about larger, long-term investments.”
Collateralized investments can come in many forms. The most popular are real estate (i.e. rental properties, fix & flips, Trust Deeds) and precious metals. Real estate has the potential to be both income and equity generating. Precious metals do not have the income component but could have an equity component over time. I prefer investments that take on both income and equity or, if nothing else, when the market softens the income remains while the equity recovers. For this conversation, I will discuss how real estate can be a powerful tool to build wealth using others money.
Be prepared to not be selfish or materialistic for this experiment to work. Have you ever consider buying your first home for someone else to live in? If even a small percentage of first-time homebuyer consider this option first before buying for themselves there could be many more people building wealth in their 30’s and beyond. Hear me out on this one…
You are 30 something years old and living in a townhome that you are renting for $1,800 a month. The townhome next door just went up for sale for $180,000. Yes, it needs a little work but nothing you cannot handle. Because it is an investment property, you are going to have to put somewhere between 15% to 35% down depending upon your credit score ($27,000 to $63,000) to purchase the townhome. You opt for an even $30,000 to bring the purchase price down to $150,000. This $150,000 you will finance for 4% interest over 30 years making your monthly payment $900.00 a month. Yes, I know this interest is higher than the current mortgage rates, but I do not want to paint you a rainbow.
So here you are. You purchased your first home, and your mortgage is $900.00 a month. This is the same townhome that you are paying $1,800 a month to rent.
You took the 30-year mortgage option to reduce the payment as opposed to the 15-year mortgage, and yes that will give you the piece-of-mind of knowing you can handle the mortgage if the future renter moves out until you can get it rented again, so I get the strategy. Now it is time to determine what you are going to rent it for? Certainly not less than what you are paying. Say you rent it for $2,000 a month. What are you going to do with the profit? A portion of the profit needs to be held for taxes, insurance, and future repairs. Typically, this is 10% (or $200 a month) of the rent until approximately 5% of the property value is put aside. As you are building to the 5% rainy day fund this leaves an additional $900 a month above the cost of the mortgage. Do you pay down the principal of the mortgage? Do you use it to save for the down payment of another rental? This is not a bad problem to have, but making the right choice is important.
Dave Ramsey says it best in his article “7 Easy Ways to Pay-off Your Mortgage Early” about the advantages of paying off your mortgage early. To meet these philosophies, it does require discipline. Discipline equals savings not only in the interest you will not pay, but also in your ability to increase your earning potential on the rent you are collecting. Do not forget that someone else is paying your mortgage off, so you are not losing anything by applying the remainder of the rent to the outstanding principal of the mortgage. You are not paying another cent to the pay off the mortgage, so why not apply the total rent (minus rainy day funds) from the renter? This will ensure you a completely paid off mortgage by the time you are 40 years old. Instead of having $900.00 income you have now increased the income to $1,800 a month and you own a $250,000 (increased value over time) real estate asset free and clear that you only spent $30,000 to acquire. This is where the multipliers start to matter as you consider your next move.
“All too often we take our eye off the prize and think we have plenty of time to save.”
If you have the stamina to apply the scenario above throughout your 30’s and you continue down this path in your 40’s with adding alternative asset (real estate), you will amass a well-diversified retirement portfolio assuming that you are applying both market related investments (401(k) plan) and real estate related assets. All too often we take our eye off the prize and think we have plenty of time to save. The sooner you start building wealth the sooner you retire.