I’ve had to wipe egg off my face numerous times back in the day, due solely to unfinished analyses. Nobody’s so good they can foresee the end game of a given analysis. I know I’m sure not. Over the decades I’ve learned the hard way that what appears to be the analytical conclusion is too many times a mirage. Here are a couple examples — one simple, one a bit more involved.

The common denominator between the two is that on the surface, the answer appears quite obvious to most.

## 2 Examples That Prove the Importance of Analyzing Your Investments

### Example #1: Higher/Lower Interest Rates

What’s the difference between 4% and 5% interest? Well, there’s a buncha difference, right? Much of the time, that’s true. However, let’s test it with a quick analytical comparison.

You’re buying a duplex that will have a new loan of \$200,000 with a fixed rate, amortized for 30 years. You can pay 4% with no points or 5% with a point, which is \$2,000. You know you’re gonna add \$1,000 a month either way to the payment in order to speed up the loan payoff.

Clearly, the 4% rate is vastly superior, right? Well, maybe.

A quick check on the HP 12c shows us that adding \$1,000/mo to a \$200,000 4% loan payment will result in that loan being paid in full in 126 months, 12.5 years. Doing the same with a 5% loan payment will pay it off in 124 months. Whoa! Wait just a dad-gum minute! How is that even possible in a sane world?! I’ve been the happy recipient of countless free drinks and a few free meals with that bet. 🙂 So, the loan is paid off sooner, you pay a couple less payments, plus you saved the \$2,000 upfront point.

There’s a hidden Bazinga! in there. Can you tell me what it is? Think about your assumptions.

### Example #2: Why on God’s green earth would anyone take 12-15% yield returns to pay off 5% debt?!

I can’t count the times I’ve been asked this question:

“Jeff, you’ve sold me on the value of having discounted notes as part of my Purposeful Plan, but why would you tell me to take note payments to pay off cheap real estate debt? That makes no sense to me.”

Once again we have data showing something appearing to be Captain Obvious(ly) incontrovertible. Let’s do the analysis, though, before we bet the ranch on our premature conclusion.

Related: The Ultimate Analysis: Cash on Cash Return vs. Overall Return

Teresa Investor already owns notes generating \$1,000 after tax, monthly. Her two best options for that income to enhance her ultimate after tax retirement income are: a) accumulate the payments ’til she has enough to buy another note or b) use those payments to retire the debt on one of her properties. It’ll take her five years to pay off the \$200,000 loan. She’ll be using three sources to do this: note payments, rental property cash flow, and her own money.

NOTE: Please notice that two of those three sources are coming from other people’s money.

Her choices in this scenario boil down to: a) buying more notes with accumulated after tax note payments, while taking years longer to eliminate her duplex debt or b) eschewing the first option by committing the note payments to the more rapid duplex loan payoff.

Let’s take a look.

In five years while applying Option A, Teresa would be able to acquire \$60,000 in discounted notes. Being conservative, we’ll assume she’s making 12% cash on cash yield, which would be \$600/mo or \$7,200/yr before taxes. We’ll apply a 35% state/fed overall tax bite, which leaves her with around \$4,680/yr. At today’s prices she’d have had to wait 2-3 years to have enough to make each purchase.

On the other hand, if she chose Option B, her duplex would be free ‘n clear in just five years with a value of \$300,000, what she paid for it. She would then have multiple alternatives as to what her next move might be.

1. Would a sale work? Sure, if the capital gains taxes were reasonable. But that begs the question: What then?
2. How ’bout exchanging all that equity into much more? Yeah… but remember, tax deferred exchanges should be avoided if at all possible. Even though I’ve done well over 200 of ’em, they should be the last resort.
3. Since she wants to have her cake and eat it too — and who among us doesn’t — she opts to refinance for some cash out. Her lender tells her she can get up to 70% of her equity out in cash. This approach allows her to get that cash without any tax liability, deferred or otherwise. Caveat: Don’t do this, then try to execute a tax deferred exchange shortly thereafter, as the IRS will much more likely than not tax that entire cash out loan amount as “Boot.” Oh, and they’re the sole arbiter on what your intentions were, and how “shortly thereafter” is defined. 🙂

Teresa then pulls out \$210,000, which she immediately uses to acquire more notes. Using the same 12% cash on cash yield, that gets her an annual income of \$25,200, or \$2,100 a month. Now, tell me again how it’s horrible to use 12-15% yields to pay off 5% borrowed money? 🙂

Her duplex is still cash flowing at around \$5,000 annually, so it’s easily paying for itself. Out of the extra \$2,700 she added to her monthly payment for 60 months, a little over half came from other people via cash flow and note payments. Her overall Purposeful Plan had already designated her personal money, about \$1,300/mo, to go to accelerating her duplex loan payoff. If she’d kept to that original plan instead of being free ‘n clear in just 60 payments it woulda taken her an additional three years and eight months to get it done. What would have been the opportunity cost for those extra 44 months?

Simple: \$210,000 X 12% discounted note yield/yr X 3.67 years = \$92,400 missed income.

Let’s say when Teresa did this she was 55 years old after the first payoff/refi. Let’s further assume that the interest she paid for the refi wasn’t 5%, but 7%. That would lower her post refi cash flow from around \$5,000 yearly to a bit under \$1,800. How quickly might she pay this new loan off, if that’s what her Plan called for?

She can still comfortably afford to contribute the same \$1,300 monthly from her own budget. She’s not gonna count on \$150/mo duplex cash flow this time. Her after tax note income as grown nicely to around \$2,350/mo. This gives her \$3,650 monthly to add to her duplex loan payment. How does that work out for her?

In a month less than six years — 71 months — she’s already free ‘n clear again. She’s now 61 years old, about four years from retirement. Should she call it a day?

IF she opts to rinse ‘n repeat the ‘refi and buy more notes’ script, here’s how it might play out.

She gets the same \$210,000 tax free cash. Gets the same 12% yielding \$25,200/yr pre-tax. Her after tax is the same \$1,365/mo as before. However, she now has her \$1,300/mo; no contribution from the duplex; and an after tax total of around \$3,730/mo from her now slightly impressive discounted note portfolio. The grand total she can now add to another potential \$210,000 refi payment is \$5,030/mo. But does that fit into her timeline for retirement?

Related: Property Analysis: Three Budget Items Not to Forget

Well, whadya know? 37 months later and her duplex is free ‘n clear once again — and almost a year before she retires. In fact, if she wanted to, she could retire right then, almost a year early.

During this analysis we’ve happily discovered a some truths.

1. Do the dang analysis to the bitter end, no matter how sure we are about what we “know” is the foregone conclusion.
2. Teresa began by contributing \$1,300/mo to her plan and never increased that amount during the 14 years she followed her Plan.
3. The truth of #2 meant that her contribution was a constantly decreasing percentage of the amount used to pay off these refis. Even at first she was contributing less than half, with other folks doing over half the heavy lifting. By the last refi, which she eliminated in just 37 months, her contribution was merely half a tic less than 26%, meaning roughly 74% of the money used to clear that last loan off came from other people.

## Conclusion

Teresa’s plan isn’t formulaic, as one Plan doesn’t fit all. Never has, never will. Not to mention the BawldGuy Axiom saying, “Most investment formulas work right up ’til the day they don’t.” However, the principles upon which the various strategies were founded, never change. She made use of Strategic Synergism.

Her immediate retirement income that first year is approximately \$87,600 a year, pre-tax. That doesn’t count anything she likely did inside her Roth IRA — or anything else. I strongly suspect, based on nearly 40 years of discounted note experience, that it would easily eclipse six figures. The very simple reason being that this post never assumed any single note she every bought would ever pay off early. The average note these days pays off in a window of 6-9 years. But since they’re virtually the perfect working definition of random when it comes to paying off, we can’t ever apply that average to a particular note. It’d be more than foolish.

Do the analysis every time, and do it to the last decimal point. The idea is to be accurate, not show how smart we are. 🙂 As I said at the beginning, refusing to do the entire analysis (or sometimes multiple comparative analyses) is a lock to wiping a whole lotta egg off your face.

Investors: What do you think? Have you ever run the numbers on an investment, only to find that the results shocked you?

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.

1. Hi Jeff, great post – thank you! I’m a numbers/data guy so I love going through examples like this with my friends and colleagues.

One clarifying question – in your first example, did you mean 5% with no points, and 4% with one point, costing \$2,000? I think that might have been a simple typo / swap of the two?

2. Good catch, Jay. That’s exactly what happened. 🙂

3. I am glad Jay mentioned your error in example one. The lower the rate, the higher the cost. But the rule of amortization states that with extra payments on a loan, the higher the interest rate, the faster it pays off. It is really simple, when you pay an extra \$1,000, you save the INTEREST AMOUNT on the remaining LIFE of the loan. At 4%, you save \$40 a year and at 5%, you save \$50 a year. If you dont believe it, try it on a 50% loan, even a 100 % loan.

• Hey Mike — Sshhhh! You’re gonna ruin my free drink fun. 🙂

• Another way to look at it Jeff. Let’s say you have 3 rentals, all leveraged. One at 4%, one at 5% and one at 6%. If you were to pay extra each month, which loan would you do it on? But Jeff, you will still be getting a FREE LUNCH, on me, when I can get down there to San Diego. Wife just had Knee Surgery in December, so I am busy taking her to PT a couple of times a week right now.

• That answer depends on a few factors, Mike, not the least of which are the balances of the various loans. Most would go after the one they could pay off the fastest. But what is the overall Purposeful Plan? It’s not a formula we can apply universally.

Let me know when you hit San Diego, as I’m never averse to free food. 🙂

4. Jeff –

Great article as always. There are two things I really liked about it.

1. Egg on your face. It takes a humble, experienced person – not just real estate investor, but person – to say I have had egg on my face before. None of us are going to get it right 100% of the time, but I always pay attention to those around me who are wiling and able to point out their own mistakes. It tells me they care enough about my success to share their failures.

2. You mention having a plan and sticking to a plan. My single biggest mistakes in real estate, which led to more and larger mistakes, was failing to stick to the very clear plan I had created. Success emboldened me to take more risks as I thought I was doing something to create my success. That led to less analysis on my part and ultimately an incredibly challenging wake-up call. I will not make those mistakes again?

Great article and thanks for sharing. Best to you always. Chris

• Thanks so much, Chris. You touch on planning as it relates to analysis, and make an excellent point. I was mentored to believe that if the analysis was honestly objective in nature, then the plan based on that analytical conclusion will be solid.

The only time any plan should be altered, or even abandoned is when the very foundational factors shown in the original analysis change, disappear altogether, or new factors appear. A simple example would be a 5 year plan to pay of a loan/loans. It’s one thing to complete that task, but quite another to buy more real estate with sales/refi proceeds when interest rates zoomed upwards to impossible levels during the payoff process. We must, as I’m sure you do, adjust to changing/disappearing/new factors. The last time I didn’t adjust to new realities, I lost three properties back in the early 80s. I remember Dad chortling it’d take quite awhile to wipe all that egg off my face. Boy was he ever spot on. 🙂

5. Hey Jeff,

I keep reading about these discounted notes and I am good with it but they aren’t that plentiful in my neck of the woods-Portland, OR. Best way to pick one or more up?

• Frankly, Jeff, you either need to be somewhat of an insider in your area, or buy notes from a fund specializing in the sort of note you prefer. Most notes bought on the street that perform well are bought by insiders who learned of the note(s) from sellers/brokers who contacted them, not the other way around.

• Notes is such a interesting niche that I have yet to truly understand but can not wait to be able to get into the game. Those are a little further down the line for me though.

Great article Jeff it opened my mind to looking at things in a different way. I am still learning to look at things further down the line not just a few years. The examples were mind blowing for me and made me realize I need to spend more time playing with mortgage/amortization calculators and really knowing my numbers.

• Think of me, Gary, when you win the free drinks. 🙂

6. This sounds like an excellent strategy. Hopefully I can find some note brokers in Maryland. Do you usually invest in notes that are in your area or outside?

7. The Bazinga! in your first example is the total amount paid.

At 4% your monthly payments are \$954.83 (plus the extra \$1,000) for 126 months – that’s 10.5 years, not 12.5 – making the total paid \$245,007

While at 5% the monthly payment is \$1073.64 (again plus the \$1,000) for 124 months giving a total paid of \$256,311

So while the 5% option has the loan paid off 2 months earlier you pay an extra \$11,304 for the privilege.

As you rightly say, it’s important to follow the analysis to the end.

• That’s certainly part of the Basinga!, Ivan. The 10.5/12.5 years thing was a typo on my part.

The fact that over the 120-something months there’s an additional \$11k paid is absolutely true, though usually in real life the choice would actually be a couple points for a hole 1% reduction in interest rate.

Have you gleaned the initial Basing! yet?

8. Sometimes when I read post like this ( very informative) it almost feels like I’m learning a new Language. Thanks will continue seeking out theses kind of post, knowing that proper analysis and planning go a along way to ensuring my growth and success. Thank you.

9. I sure am glad I got started on your first position, discounted, warrantied note fund. Now I’m about to migrate my Roth IRA to self directed a la John Park and buy another. My net worth has doubled in the past three years since I ditched that dusty musty 401K.

• I suggest your story, Greg, will end up as a classic case study. Thanks for the ‘fix’ I got in reading your comment. 🙂