In last week’s post I spoke about why your employer sponsored 401k is a loser.
Since its inception over 30 years ago, it simply hasn’t produced the promised results. The only real empirically demonstrable fact you need to know about ’em is that the average American turning 65 has $100,000 or less in their 401k account. Not quite the retirement bonanza anticipated by far too many. In fact, it’s a major reason why so many of us remain in full time jobs into our 70s.
I offered an alternative. Some readers had questions, most of ’em striking to the heart of my approach. So this week, let’s just pose the questions, I’ll answer ’em as specifically as I can, and we’ll get down to brass tacks. I’ll be paraphrasing the questions.
Though you spoke of risk aversion both nearing and in retirement, it seems your approach didn’t move away from risk. Would you address that?
Short version — Yeah, it’s riskier. However, that assumes the investor is a member of the ever increasing tribe known as DIYers, those who insist they can become experts cuz they will it so. I know that sounds a tad harsh. But I’ve spent much time in my career cleaning up DIY spills on ‘aisle 5’. Without exception, every single note I’ve bought or brokered was found on ‘the street’.
Today’s market makes that unnecessary. There are relatively large note ‘funds’ now, and many are governed closely and strictly by the Securities and Excahange Commission. (SEC) Much of the due diligence most newbie note investors wouldn’t even know to do has been done by highly seasoned pros, who’ve literally done thousands of ’em. Furthermore, some of the funds, not most, offer both preferred returns to their accredited investor/members, AND warranties on notes. Huh? What? Note warranties?
Why don’t you tell me about the warranty those super safe, risk averse stocks offered to ya as you saw your hard earned investment capital circling the drain back in 2008? What?! They didn’t offer one? I’m both shocked and chagrined. Speakin’ only for my own fund, specializing in first position notes secured by real estate, there’s more risk reducing reality than a warranty. When stocks, or for that matter, real estate goes south in a hurry, and we all know they both can and do, what happens when the value falls below the purchase price? Worse, what happens when the real estate value drops below the loan balance? Oops. What happens is you have a couple choices. You either bite the bullet and take the loss, or you sit it out ’til the market comes back. That could take a year, or a whole buncha years. We never know, right?
Yet, that homeowner who lost their home, lost it to the owner of the note on which he defaulted. So, the note owner did NOT lose everything. They simply moved from lender to homeowner. They have a whole lot more than a big bag of nothin’, which is exactly how the home owner ended up. Furthermore, that note owner will rent the home out and earn net income. Will it equal his old note payment? Not likely in my experience. But the market will recover. Values will return to the norm — most of the time — and the note owner will remain whole, instead of watching their investment capital disappear like steam in the wind.
The note investor ends up with security backing their investment, the real estate. They get a warranty. They make a far better cash on cash and overall yield than those remaining on Wall Street while retired. One last note, pun intended. Let’s say you follow the advisor at work who tells you your yield nearing and in retirement will be around 4%, and also assume you ended up with $1 million bucks in your 401k. That’s a whoppin’ $40,000 a year — BEFORE taxes. Heck, you can do that with just half as much without ever buyin’ one single note in a fund with an 8% preferred return. Thing is, if you followed my advice from last week, that $40,000 is TAX FREE. The ‘other’ approach wins again. It’s at this point I can’t help myself, and must ask the question beggin’ to be asked.
How many of you know ANYONE who’s retired on even $50,000 a year, before tax, via their work related 401k? There’re more of them than unicorns, but it’s close. 😉
You assume the 12-15% cash on cash yield from discounted notes will always be in place. What happens when another recession hits and there’s very high inflation, the double digit variety? What if you were in, gulp, California and that happened?
Oh my Lord! Did BawldMom use an alias then ask that question? 🙂 Talk about teein’ it up.
The first note in which I ever invested, was acquired in what later turned out to be the highest inflationary period for America since the end of WWII. I made roughly 13.8% cash on cash, and almost 20% overall. Just a few short years later inflation had risen from just under 10% to 14%. Prime rate was 20%. Oh, and those notes that might suffer during inflation and recession? They rose in yield and dropped in price. Since those buyin’ ’em for income didn’t much care about future note value, they just kept acquiring as many as they could prudently afford. The value of a home securing a particular note bought in 1982, a horrifically bad recession year, was worth FAR more just seven years later in 1989. In other words, the note became way more secure. Maybe the collateral investors get in the stock market would do the same? What?! There IS not collateral in the stock market? Who knew?
For the Record:
In my 38 years of note brokering/investing I’ve yet to see a note sold at discount generating a yield less than double digits. Could it happen? Oh, you bet it could. But it’d be the first time I’ve ever seen it, including my two note mentors, both passed, who began as note investors just a few years after the end of the Korean war. They likely wouldn’t understand the question. 😉
Now, about California’s perceived higher risk. Well, let’s all say it in unison, shall we? A big Captain Obvious, DUH!! 😉 For Heaven’s sake, why do ya think I abandoned California over 11 years ago? Think it might’ve been cuz I no longer had confidence in that region’s market? Ya think? Or, do ya think I was bored, and thought, “Hey, I could turn my life upside down, and leave a two generation business behind? Yeah, let’s do that!”
What happens when one of your 12% notes gets paid off and there’s only 8% notes available? Could that happen?
Answer: It could happen in a heartbeat, and don’t let anyone tell ya it couldn’t. If we’ve all learned anything about the economy in the last half century, it’s been that anything can happen. Still, my family’s been in the business since Eisenhower was in office, owning our own brokerages beginning in 1964, and we haven’t seen it yet. But for the sake of this post and the question, let’s assume it happens next year.
So Freakin’ What?
Do you think stock dividends, treasury notes and the like would, in that scenario, be higher? Cuz if you do, I know a bridge in Brooklyn I can sell ya, cheap. The next time I see the discounted real estate backed discounted note market produce yields the same or lower than Wall Street will be the first. What goes unsaid is that no down economy in America ever really recovers ’til the common perception is that real estate has also recovered, nationwide. Ask regular folk what they think of our current ‘recovery’, and most of their answers couldn’t be published here. Ask note investors how they did in 2008, and do it right after you asked others in the same room how their 401k plans fared. Here’s what will most surely happen next. The note investors will all be taken out to lunch by those who got slaughtered by the downturn. 😉 In fact, let’s pile on for a second here. My clients with EIULs made 2% in 2008, when their neighbors were wondering IF they’d even be able to retire.
What is the minimum required distribution from a retirement account for a 71 year old? Is that distribution really all that bad, especially since the return for all those years was only 4%?
Let’s take ’em in order, shall we? The phrase ‘minimum required distribution’ is not something to merely pass over. It’s the government FORCING you to take and pay taxes on income against your will, and for many when they don’t even want or need it. Embedded in that question is that since they only made 4%, that shouldn’t be something about which to worry. Are you freakin’ kiddin’ me?! Where are they handing out these white flags? After all, we got you this far into retirement paradise, surely you believe that 4% is reasonable, and that you should learn to live on it, right? People, in my view it’s horrific as soon as the government tells us how we’re gonna spend our retirement income, and IF we wish to cannabalize our very retirement net worth.
Since when does a married couple who’ve made six figures the last 20 years of their working life, look at $40,000 a year before tax in retirement income as paradise?
Folks can frame it any way they wish, but once we’re forced to begin eating into our own principal in retirement to live on, we’re inarguably in the race between when we run outa money and when we die. Yeah! Right on, man! Where do I sign up to guarantee THAT happens to me?!!
Am I on candid camera? 🙂
Are we gonna take seriously those who defend 4% yields? Then, in the next breath they say it’s really not so bad that you’ll hafta hope ‘n pray you don’t outlive your lifetime of savings and investments capital? What’s really happening when you read/hear folks doing those things, is they’re tellin’ us to watch their right hand, as their left hand isn’t doing anything. Remember this if nothing else: Everyone you know who’s nearing retirement or retired, had an employer match of some sort. How’s it workin’ out for ’em now?
We’re not finished by any stretch. There are many more questions to address, and some very solid observations to acknowledge. Next week we’ll continue with this. Thanks so much to the commenters’ questions. Every single question was spot on topic, making solid points.
And thanks so much in advance for allowing my smarty pants side to make an appearance. 😉
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.