Financial mistakes can have a HUGE impact on your future retirement savings—the opportunity costs can be enormous!
Mindy and Scott move past previously discussed mistakes, such as housing and transportation, and dive deep into relationship money mistakes, travel, spending, retirement planning, and tax issues that can cost you tens of thousands of dollars in your retirement accounts.
They also shed light on some of the “low-hanging fruit” money missteps, as well as touch on spending and lack-of-planning issues that can have an even larger impact on your financial future.
This episode truly is for anyone who has money and wants to have more.
Scott: Welcome to the Bigger Pockets Money Podcast show number 93, where Mindy and I talk about financial mistakes and how to avoid them.
Mindy: Being in a relationship shouldn’t be an adversarial experience, and if that’s what you’re having, you need to really review and see if this is really the right relationship for you. But be on the same team with pets be on the same team with kids be on the same team with your wedding, get on the same team by having a prenup.
Speaker 3: It’s time for a new American dream. One that doesn’t involve working in a cubicle for 40 years, barely scraping by. Whether you’re looking to get your financial house in order, invest the money you already have, or discover new paths for wealth creation, you’re in the right place. This show is for anyone who has money or wants more. This is the Bigger Pockets Money Podcast.
Scott: Ask everybody, I’m Scott Trench. I’m here with my cohost, Mindy Jensen. How you doing today, Mindy?
Mindy: Scott, I’m having a fantastic day. I’m very excited about today’s episode because it was inspired by an article that I read online. It’s called The $51,000 Mistake That Thousands of Retirement Savers Have Already Made. And what the article… We’ll link to that in the show notes today, which can be found at biggerpockets.com/moneyshow93. But what that article basically says is when you raid your retirement account to pay off debt, the small amount of money that you’re taking out now no longer has the chance to grow and can cost you exponential funds in the future by not being able to grow.
So, basically don’t raid your retirement account when you’re trying to pay down debt, instead find another way because the power of compound interest, and I don’t really think we need to get into that so much. But that inspired me to post in our inter office communications channel and say, “Hey, I crowdsource from our fellow Denver office mates,” and on a side note, if you are interested in becoming a fellow Denver office mate, Bigger Pockets is hiring, and you can find all the jobs that we’re currently hiring for at biggerpockets.com/jobs.
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Mindy: Okay, that commercial aside. We have a lot of really smart employees here, and they gave us quite the list of things that they feel are financial mistakes, and we will share with you how to avoid them. Number one, as we harp all the time, would be housing. And since we have already discussed this many, many times, we’re not going to really focus on this too much. In a couple of weeks we’ve got Craig Curelop from Episode 35 coming back on the show to talk about house hacking. Scott, you have been house hacking in the past. Why don’t you tell us what house hacking is?
Scott: Yeah, sure. So, the main theme here is that a big mistake people make is they’ll buy too much house and that will commit a lot of their accumulated life savings and a large amount of monthly cash flow, making it very difficult to build wealth and other places. House hacking eliminates that problem. It is the act of buying a place with extra bedrooms or duplex triplex or quadplex, with extra units, renting those units out in such a way that they might cover the mortgage or even generate a cash flow for you while you live there. It removes the financial burden of housing and places it on tenants or other people who are inhabiting the property. I might take from you, so that you can live for free and make money, and there’s an investment return from your housing.
Mindy: Yes. Now, just like we said in the beginning, or just like Scott said in the beginning, you become house poor when you buy too much house. Make sure that you can comfortably afford the entire mortgage payment, before you get yourself into this house hacking situation. It’s not going to do anybody, it’s not going to do you any favors to have a house that you can barely afford, and then also nobody wants to live there. Or all your tenants leave at once, even though you’ve got a lease, and you should have a lease when you’re house hacking. Even though you have a lease, that doesn’t really stop a tenant from just not paying you. So, you definitely want to be able to afford all of that on your own. It’s just really nice to have somebody else make the payments for you.
Scott: Yeah, buy from a position of financial strength, right? That means you have you spend less than you earn, and you’ve got 10, $15,000 at least in addition to the down payment, closing costs and any expected repairs you’re going to make in the first year of home ownership. That’s how you protect yourself from that downside, but we have a lot of information on housing on episodes… We had two episodes recently 88, 89.
Mindy: We had Episode 87 was How To Save for a Down Payment, and Episode 83 was How To Prepare To Buy a House.
Scott: Yes, perfect. So definitely go check out those two episodes if you’re interested in learning more about how to avoid mistakes with your housing purchase.
Mindy: Yes, yes. There’s a lot of things that you can do to hack your housing and live for free. Okay, the next one up is a car. Now, I don’t know about you, Scott. But I have purchased two new cars in my life, and while I don’t regret them, they were definitely not smart purchases. I mean, I still have them today. One is a 2003, and one is a 2010. They get me where I need to go, but I could have very easily bought a used car and made it to the same place just as easily. So, have you ever bought a new car, Scott?
Scott: Yeah. I did. I bought a new 2014 Toyota Corolla, and you can make worse financial mistakes in life. I’m sure we’ve heard over the course of 100 episodes here on Bigger Pockets Money. The fact of the matter is that cars lose about on average 60% of their value over the first five years of ownership. So, it makes a lot end their life span, especially when you’re talking about things like an economy car, like a Corolla, or a Civic or something along those lines, their lifespan can be 15 to 20 years.
So, you can let somebody else take the hit on that depreciation if you buy a five, six year old model, and still get a reasonably new car that’s reasonably well maintained just after that depreciation has occurred. Other things here, not to state the obvious, but if you’re buying a jacked up F250 worth $40,000 brand new, you have a different podcast you should probably be listening to. But that that kind of stuff, aside from that, when you get into like what car to buy? I think it really is that couple years old model that has had some of that depreciation already take effect, and doing your homework researching.
Mindy: Yeah. Now, what do you say to people? The most common thing I hear when I say, “Oh, you should buy a used car?” “Oh, I don’t want to get somebody else’s problem.” What do you say to people who say that?
Scott: I think that avoiding somebody else’s problem in this context is a very expensive solution. I think that it’s a game of probabilities here, which is all of life and all of this finance stuff. Things can go wrong with a new car, things can go wrong with somebody else’s car. Somebody could have been in an accident or not reported something or not taken care of something, or not changing the oil. But on the flip side, if you buy a new car… I bought a new Corolla, right? The first year of ownership, I get rear entered at a red light. Thousands of dollars of value on my Corolla are destroyed, and that’s an equivalent opposing risk, I think, to buying a used car. If I bought a used car that already had some of that depreciation, that hit that I would have taken value would have been, I think, dramatically different to my car than if I had bought it new.
I think that there’s a bunch of trade offs here. And from all I can see, a lot of that trade off seems to be weighted… From my experience, at least owning a Corolla, a lot of that advantage seems to be weighted in favor of owning that used car. Here are some other additional disadvantages besides the depreciation that I instantly take after driving an awful lot. I’m losing 40, 50, 60% of my value for the first five years. I am paying higher registration fees to register my vehicle in Colorado as a new vehicle. I paid a premium for my license plate tags and such in the first couple of years of ownership. Those have drastically declined here in the city of Denver. Insurance rates go down to insure the vehicle because it has a lower value over time. So, there’s a whole bunch of advantages that I think largely offset some of that risk that the previous owner didn’t change the oil or is lying to you and committing fraud.
Mindy: I agree. I have an example that I like to share. I don’t think it’s outside the norm. I bought an Acura Integra from the second owner of the car. I knew he was meticulous and taking care of the car because he was a friend of mine. But you can tell that the seller is selling you a meticulously cared for a car when they give you a stack of papers this big with all the receipts for all the work they’ve ever had done on the car. So, that right there, if they’ve got all the receipts, that’s a great way to hedge your bets. I bought this car for $2500. I drove it for 100,000 miles, and I sold it for $2,000 or $1500. I can’t remember how much I sold it for, but I sold it for way more than I thought I would be able to sell it for after getting 100,000 miles out of it.
That was worth and it still starts. It flooded. The whole car flooded, and it still started. It was a great, great, great car and I would buy those again. Acura is a Honda product, and I think Hondas and Toyotas are a really great hedge against your car bets.
Scott: Was this the star attraction of the parking lot wherever you drove it? I’ve envisioned this car in my head-
Mindy: No. [inaudible 00:11:42] my other car at the time, but no.
Scott: Yeah. I think that’s a theme here is just like if you’re going for the great look good car, this financial independence journey must be a little more difficult for you.
Mindy: Yeah. So in high school, I won third place in worst car at school. Todd [inaudible 00:12:05] won first place. His was spray painted. I think it said Motley Crue on one side and maybe Metallica on the other. It looked like he painted it with a broom. So, Todd you rightfully won. But I wasn’t that far behind. Okay, let’s move on to relationships.
Scott: Yeah, this is a huge… So, housing and transportation, obviously too big line items in the budget. But relationships seems like it’s been a real central theme to a lot of the conversations that we’ve had with guests on the Money Podcast over the years here. We have a number of challenges that come up in relationships. Where do you think we should start Mindy?
Mindy: Well, when I asked all of the Denver peeps for examples of financial mistakes and how to avoid them, they did not disappoint. The first thing on the list was engagement rings, and this is actually a dig at you Scott, you had literally gotten engaged the night before. So congratulations to Scott and Virginia, who will make a delightful couple and be happy forever. And while this teasing was aimed at Scott, there’s a lot of truth in this, the a diamond is forever, and you should spend too much salary on your engagement ring, and it has to be a diamond. This whole thing came up in 1947, De Beers was sitting on just a giant pile of diamonds, which was going to devalue, you know the law of supply and demand. Oh, this is going to devalue the diamonds. Let’s make them rare.
So, they locked away a bunch of diamonds. They came up with the slogan, in 1947 10% of engagement rings were diamonds. By 1990, 80% of engagement rings were diamonds. I’m not dogging on diamonds. I have a diamond engagement ring. I love it. I think it’s beautiful. But this concept that you have to save two months salary to pay for a ring is absurd. You can get very, very good quality fake diamonds like Cubic Zironcia. Who knows? Who can tell the difference between a Cubic Zironcia and a diamond by looking at them. Nobody except a jeweler, and you know how many people have come up to me and said, “Excuse me, let me see if your diamond is really a diamond or if it’s a Cubic Zironcia, zero, and I’ve been married since God was a boy. So, it doesn’t matter that you have a diamond on your finger, and it’s so stupid to pay so much money for something, especially when you can’t afford it. Now, Scott, you did recently get engaged, care to chime in on this?
Scott: Yeah. I think one of the things that people gloss over on this is that a key to it is making sure that, for me, that my fiance is happy with the ring that is chosen there. So, I spent much less than two months salary on the engagement ring. I didn’t go overboard with that. But some things that I did do is, a diamond was something that we discuss that we wanted to do. And a good solution alternative to the really expensive diamonds is these synthetic lab created diamonds. They’re real diamonds, they’re just created in a factory setting. So, you can get some really good color, some good clarity, a good cut those kinds of things for a little bit less of a price. And as a bonus, nobody is dying to harvest these diamonds from other countries. It’s a really good moral and financial way to get a little bit better of a deal, I think on an engagement ring.
Mindy: I saw a tip online. I didn’t verify the authenticity of this claim. But I mean, it sounds good. I saw a tip where if you get a created white Sapphire, it is a rock that is second only to diamonds in hardness, and it looks just as beautiful as a diamond. It is almost free. I think they said you could get a nice one carat for $200. I don’t know that I would have taken the same advice 1,000 years ago when I was getting engaged because I didn’t even have the internet barely when I was getting engaged. I didn’t know that this was created, and there wasn’t all that information on the blood diamonds. We can harp on this forever, and I don’t want to. But if you are just starting out, if you are in a relationship, and the ring is more important than the marriage, there’s a problem.
Scott: Yeah, I agree. I think a key here, a theme across all the problems that come up with relationships is being on the same team and being very clear about what your goals are as a couple and what you’re trying to get to. And if a really expensive engagement ring is what one partner wants then the other partner I think needs to understand, hey, is is that tenable? Is that okay?
Mindy: Don’t go into debt to get an engagement ring. That’s not the great way to start merit.
Scott: Perfect. Yeah, I think that’s a great rule. I think you can apply the same concept to weddings. We’re full throttle here picking venues, and all that kind of stuff with our wedding right now.
Mindy: You could spend $100,000 on your wedding. Are you going to have a better marriage because you spent $100,000 on your wedding, and I only spent 5000 on mine? No.
Scott: You may not even have a better wedding. It’s seems like a lot of the good or bad wedding stuff here has to do with political family dynamics.
Mindy: You know what, that’s a really good point. Spending all this money on your wedding venue and on your wedding and having the perfect flowers and having the best bridesmaids dresses and all of that doesn’t change the fact that your mom hates your Aunt Sally, and they’re going to fight at your wedding. So, spend a lot more time on the guest list. Who you want there. What do you want? It is your wedding. And spend a lot of time on the wedding that you want within reason.
Scott: The last thing here on the wedding and engagement side is that the concept of the prenup, the prenuptial agreement where you discuss assets and money with your partner before things and I think Aaron Lowery put it perfectly in… I can’t remember what episode it was. But-
Scott: In Episode 81? Yes, thank you, Mindy. Where you don’t get insurance for when your health is good, and if things go poorly, a set of rules similar to a prenup is going to govern how assets and money are going to be determined in the relationship. It’s just a question of whether you want those rules to be determined by the state, which could be really ambiguous depending your circumstances. Or if you want to just hash it out ahead of time in an appropriate manner. I think that’s the last concept to go in there on the wedding side of things.
Mindy: Let’s talk about after the wedding, Scott. Let’s talk about having kids.
Scott: Yeah, so-
Mindy: The title of this episode is Financial Mistakes and How To Avoid Them, and having kids is not a financial mistake. But it is definitely a financial drain. We’ve all read the articles, it’s going to cost $280,000 to raise your kids from zero to 18. Yeah, if you buy them everything they ever want. It doesn’t cost $200,000 to raise the average kid. And yes, there are always outliers. There are kids who have medical issues, there are kids who… Actually that’s kind of the only outlier. If your child has medical issues, I don’t really consider that to be the cost of raising a child. But I guess you really should.
Anyway, just having kids in general is expensive. It’s more expensive than not having kids. Well, not having kids is really easy. Scott do you know how babies aren’t made. I know how babies aren’t made, and if you don’t, there’s a lot of information if you Google it. Don’t Google it at work, because you’ll probably get some not safe for work information as well. But there is definitely a way to not have a baby or to significantly increase your chances of not getting pregnant. And if you don’t want to have kids when you’re 20 that’s a really good time to not have kids. If you don’t want them when you’re 30 or 40, that’s a really great time to not have kids too. But being financially unstable is one of the worst times to have kids.
Scott: Yeah, I couldn’t agree more. I’d also say in that same vein that obviously the same with a relationship, both partners need to be on the same page about when and how many kids are going to be coming along.
Mindy: Yeah. And you know what, I would say have that conversation before the engagement ring conversation.
Scott: That’s right.
Mindy: Because it’s perfectly acceptable to not want to have kids ever. But I find it very unacceptable to marry somebody who wants to have kids when you know you don’t want to have kids. Have that conversation. It doesn’t have to be a first date conversation. But you definitely want to have that conversation.
Scott: On a similar note, pets can be a major financial drag
Mindy: Thank you for opening that can of worms, Scott.
Scott: Having a pet, getting a pet is a choice.
Mindy: You know what? I’m going to say it’s a privilege.
Scott: A privilege, yes.
Mindy: It is not a choice, it is a privilege to have a pet, and we are not saying that pets are bad. We are saying if you can’t afford all of the vet bills, and all of the taking care of this animal, then you should have no business having an animal at this time. It is a financial mistake that can really drain you, especially if you do want to pay all the vet bills. Your dog has cancer, oh, I’m going to go through chemotherapy. But now I can’t make my house payment. That’s not the right time to have a pet. You need to be in a financially advantageous position in order to experience the privilege of owning an animal.
Scott: Yeah, I think that’s a really good way to put it. There’s a lot of stories about how animals… I typically hear this around dogs, it could be cats too. I’m not sure. But a dog has cancer or needs a surgery or whatever, and the owner needs to spend 10, 15, $20,000, or more on vet bills related to that. And I think that’s fine. I can only imagine how hard of an ethical dilemma these things pet owners must face at that point. But that dilemma needs to be taken into account prior… If you don’t have a pet, prior to getting a pet so that you know when that time comes, I may say that I’m only going to spend three, five, whatever it is, but then that’s my pet. That’s a member of the family that I’m going to need to take care of. I need to be financially prepared to take care, to cover any expenses that will come up that I think I would be even remotely likely to have to handle in owning this pet. And that’s the responsible choice prior to owning a pet.
Mindy: Yep, exactly. I think all of this can really be summed up as a financial mistake, and how to avoid it in a relationship is to be on the same team. Being in a relationship shouldn’t be an adversarial experience. And if that’s what you’re having, you need to really review and see if this is really the right relationship for you. But be on the same team with pets, be on the same team with kids, be on the same team with your wedding. Get on the same team by having a prenup. Aaron said so succinctly, “You already have a prenup, the divorce laws in your state.” So if you don’t want those laws dictating how your divorce goes, you need to write them yourself.
Scott: I love it. I mean, this is a huge bucket of issues here. I think we’ve covered a couple of them pretty well. Hopefully we’re not offending anyone or going too far with any of these things. But I think it is a matter of just understanding the consequence of these things, and these choices before you go into them and having those conversations.
Mindy: Yep. And if we are offending you let us know. Let us know what you think we got wrong. You can reach out to me at [email protected] You can reach out to Scott at [email protected], or you can reach out to both of us at [email protected]
Okay, moving along to travel. There are so many ways to spend so much money on travel. But there are lots of ways to save money on travel. Traveling business class, paying to travel business class, in my opinion, is a mistake. Now, I will caveat that with I have very short legs. My knees don’t come anywhere near the back of the seat in front of me on an airplane. You are taller Scott, I can see that your legs might touch the back. We’ve got a super tall guy in the office, his knees definitely touch the back of the seat, and he probably has to sit sideways, and I bet that’s uncomfortable. So, if you’re like seven feet tall, maybe that doesn’t apply to you so much. But for me business class is a complete waste of my money. Now if you’re going to give it to me for free, I will take you up on that every single time.
Scott: Yeah, I fly Southwest. So there’s no business class there. But I think business class is a really good thing. If you listen to the Bigger Pockets Money Podcast, you save your pennies, you invest wisely, you earn a good income. And then over the course of 10 years become financially independent, and then your wealth snowballs and you become very wealthy at the age of 60, 65, 70. That is the time to begin flying business class when you have a large surplus that you need to spend. Until then I think that economy in traveling as you can is the appropriate way to go.
However, that said, I think the big opportunity here in terms of travel is in the concept of travel rewards. This is something that I really got my education on this concept from the ChooseFI guys ever at the ChooseFI Podcast. But yeah, I mean, this credit card hacking and travel rewards has been a game changer for me, and my travels. I’m 29, we just talked about weddings, and engagement rings, and all that kind of stuff. A bunch of my friends have been getting married. That seems like it’s only going to continue accelerating over the next little bit. I’m flying all over the country to visit parents, Christmas, Thanksgiving, weddings. And those are things that I really think would be difficult to avoid if I want to maintain my personal relationships and friendships.
The Southwest companion pass, which I got by travel hacking, getting two different credit cards, one that gave me 50,000 points as a sign in bonus, and the other that gave me 60,000 points as a sign in bonus, which gets me to 110,000 Southwest air points, which gets me the companion pass, which allows me to bring Virginia, my fiance for free every time I book a flight has saved me thousands of dollars over the last year and a half. And that kind of travel hacking can really make a big difference for people who do need to travel, which I think is an increasingly large segment of the population these days.
Mindy: Yep. And even if you don’t have somebody to consistently travel with the travel hacking where you got the credit card that gave you 50,000 points. 50,000 points is going to get you what, like five or six round trips, at least. I mean, some of those round trips are even less expensive than that depending on where you’re going. So, just mitigating your travel costs by getting free flights and free hotels and free… I think they even have car rentals now. I’m not sure. There’s a lot of ways to reduce or eliminate your travel costs. The ChooseFI episode is episode number nine, where Brad and Jonathan really dive deep into how to do this. I will give the caveat that you do need to be able to pay off your credit card every month. Otherwise, you’re paying interest to get free travel, which doesn’t make any sense.
Scott: Yeah, absolutely. This is for… You’re in a good financial place. You’re not going to accumulate credit card debt. And I haven’t gone crazy with this. I’ve opened up three credit cards in the last two years. So it’s not like I’m going nuts and opening and 50 like some of these other guys. Not to say that’s going nuts. Some of these guys are educated and know all the consequences of what they’re doing. But just a little bit of openness to that subject, I think can really result in some good savings. And like to your point, those miles they count for airfare, they count towards car rent. You can use them toward car rentals. You can use them for hotels, so you can really make a dent on your expenses there.
Mindy: Yep. I used to think, oh, I don’t need a Hilton Hotel. I don’t need a Marriott Hotel. I’ll just stay at the tourist hotels, which are still fine hotels. I really like a hotel that gives me a free breakfast. But these travel rewards, I mean, when it’s free, that’s even less than paying for a cheap hotel room.
Scott: This might sound bad, but this maybe isn’t a huge surprise to given my thing. But when you have to fly across the country in spring and bring your significant other, and get a rental, and get a hotel room. And it’s going to cost you 1,000 bucks to go to a wedding or something, that makes a little harder to enjoy sometimes. A little bit… that cost is kind of in your mind a little bit, and this from a mental perspective has really helped me enjoy things a lot more. Maybe that’s just how I’m wired. Maybe no one else is feeling that way, but-
Mindy: No, I’m like that too.
Scott: It makes life a lot more enjoyable when you go on a free vacation.
Scott: All right. Hope you’re enjoying the show. We’ll be right back after a word from today’s show sponsor.
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Okay, coming up next are tax mistakes. Scott, what do you think are some financial mistakes that people make through taxes?
Scott: Yeah. I think… I’m not a CPA, so I’m not going to give tax advice. But when people move large amounts of money around or are considering moving large amounts of money around, they’re often not considering the tax consequences of those decisions. And largely, that’s because they’re… We talk about saving a lot of money. They’re not going to their CPA. CPA not CFP, CPA, the accountant, prior to making those changes.
Let me give you some examples of things that I’ve seen pop up in Facebook groups or discussions over the past couple of months. I’ve got a house, and I’m pretending to be somebody. I’ve lived there for four or five years, I’m considering keeping it as a rental. Well, that’s great. That’s great you want to keep it as a rental. But if you wouldn’t buy that property today as a rental, you may not be aware that you only have another two years or three years before you can… to sell it, where you get through that loophole where you don’t declare capital gains on the property’s value increasing. And that can be a huge advantage to selling a home that you’ve occupied, rather than keeping it as a rental over time. I’m not saying you should or shouldn’t, I’m saying that if you’re not including your CPA in that decision, you may cost yourself tens of thousands of dollars or hundreds of thousands of dollars, depending on the value that’s at stake there.
Another big one. Should I sell a rental property? Or should I refinance? We had a question the other day about someone who was asking, should I liquidate my 401(k) to pay down my mortgage? I’m not a CPA, but that sounded like a terrible idea to me, because you’re going to… If you liquidate your 401(k), you’re going to realize income when you do that. You’re going to incur a penalty. And you’re going to use that to pay down a mortgage, which is partially tax advantage. The interest at least is tax deductible. So, there are major tax consequences, especially to moving large piles of money. Especially when they’re related to home equity, when they’re related to rental property equity, when they’re related to retirement accounts, starting businesses, that really I kind of see people starting to veer off a cliff.
Luckily, all these conversations, basically people are like, go talk to your CPA. But that’s what I wanted to get a point out with these tax mistakes here is that if you’re not aware that you may incur a capital gain tax, and there’s ways to avoid that or change the way you’re approaching things, you talk need to talk to CPA.
Mindy: Well, and let’s talk about having a CPA. Do your taxes and getting a consultation from a CPA. If you have a plain old job, and you have no deductions outside the standard regular person deduction. What is it $24,000 or something like that? And you have no anything else. You don’t need a CPA. If you’re filling out any other lines on your tax form, you need to talk to a CPA. Maybe not every year, maybe not have them do your taxes every year, but you definitely need to talk to a CPA. This is my situation, what do you recommend? And see what they say, “Oh, you need to do this. You have all of this money that you’re paying in taxes that you don’t need to pay?” Or if they can’t do anything for you, they’ll say that too. Unless you’re just… Here’s how much I made, here’s how much I owe the end, you need to talk to a CPA at least once.
Scott: Yeah. I’d say, look, if you have a net worth of less than $20,000, and you’re making a W2 income, and whatever, then you don’t need to talk to a CPA. But I put a caveat on that with if you have a large amount of assets or considering making changes to your asset allocation by selling something and putting it somewhere else, or selling stocks, investing in real estate, selling real estate, investing in stocks, those are things that you need to talk to a CPA about because you can lose a lot of money. And you may look back and be like, “Man, if I’d structure that differently, I’d be up 30, 40, $50,000.
Mindy: Yep. Okay, coming up into that capital gains and withdrawing from your retirement accounts comes back to the article that I read that inspired this whole episode, which was raiding your 401(k). Now, I’m sure there are times that raiding your 401(k) is not necessarily inappropriate. I won’t call it raiding my 401(k). I don’t know if I told you I bought a house last week.
Scott: Yes, I did hear this. Congratulations [crosstalk 00:36:25].
Mindy: Yeah, it is a very ugly house. I will be making it look very pretty. And I will be making videos for the Bigger Pockets YouTube channel, and you can follow my progress. But basically, I needed to be able to move fast on this house. My current house has a large amount of equity due to forced appreciation when I bought it ugly and made it beautiful. So, I borrowed from my home equity $200,000. I borrowed $50,000 from my 401(k) because the 401(k) that I have allows me to borrow. I have to make payments back. My husband also borrowed from his and we sold our NSX to fund the purchase of this house. Plus driving it just gave me the heebie jeebies because it was like too nice for me. So we were able to pay cash. I’m doing little air quotes, if you’re not watching this video. We were able to pay cash for this house, which allowed us to acquire it early.
Now, I didn’t pull money out of my 401(k) as a withdraw, so I didn’t incur the 10% fee tax. I didn’t incur the 10% fee, and I didn’t incur the income tax, because I’m just borrowing it and I’m making payments back to myself at have I think 5% interest rate, which isn’t so bad. And once I sell my house, if that’s what we do, or once I sell stocks next year, I’ll be able to pay back my 401(k) loan. So, while I think raiding it and taking the withdrawal out is incorrect, you can still sometimes borrow from your 401(k) as long as you’re making payments back. Some of the rules around that are if you get fired from the job, and it’s a self employment, so I’m not going to get fired. But if you get fired, then you need to be able to pay it back within something like three months. This is also very plan specific. But if you need money, and you have money in your 401(k), talk to your 401(k) plan administrator to see if taking a loan is an option.
Scott: Yeah, and let me just chime in here with this that this is a really tax advantaged, or it appears to be a tax advantage way to purchase real estate. You’re not having to sell anything and realize that he gains in order to get access to liquidity, you’re not having to just leave several hundred thousand dollars in your bank account for a very long period of time not earning a good return on invested in order to purchase real estate. You’re taking a HELOC and you’re taking a loan against your 401(k). A really responsible and appropriate way I think to purchase real estate given your situation. A situation that we hear a lot that I’m a little more averse to is I’ve got $100,000 in my 401(k), $2,000 in my bank account, $2,000 in credit card debt. And I’m going to borrow $50,000 from my 401(k) to get started in real estate. What do you think?
The answer is, I think that’s investing from position of financial weakness. You have a large net worth and are financially independent, and are using this as a temporary source of liquidity. If push came to shove, you could sell assets to instead have purchased this property. You’re just choosing to access liquidity in this manner. So I think that’s a really responsible way to put it in your situation. But would you agree that maybe in the other situation, that’s not that’s much more of a stretch.
Mindy: You said borrow from the 401(k). What I hear is people saying I want to cash out my 401(k) to start investing in real estate. I like-
Scott: That is just a [crosstalk 00:39:45] straight up no for me.
Mindy: I really hate that. I like borrowing from a 401(k) as opposed… Well, so you know that’s again really situation specific. If you’re able to make the payments back to your 401(k) then I don’t see a huge issue with it because you are paying yourself back. If I have to pay interest to someone, I’d rather pay it to myself than to a bank or to a hard money lender. A lot of people in that particular situation are unable to get a mortgage. So they would have to go to a private money lender or a hard money lender. If they’re just starting off in real estate they probably don’t have a huge private money network that they can tap into, so they would be forced to go and get hard money, which is interest rates on the very low end 8% and up to 10, 12, 15%. As opposed to paying 5%-ish to yourself to repay your 401(k) as long as you can swing the payments. I think that’s a better choice. But again, situation specific.
Scott: Fair enough. I would just caution people who are looking to borrow against the 401(k) as their major source of liquidity.
Mindy: Oh, yeah.
Scott: That borrowing is going to put you in a risky position, just like taking too much of a loan from any source would put you in too much, in a weak position. But inverse Yang if it’s that versus interest that you’re paying to somebody else, I think like you just did, I think it’s a great solution.
Mindy: And I would hope that it was a smoking hot deal. My house was literally a smoking hot deal. It smells like cigarette smoke.
Scott: Yeah, nice. Well, some of the bigger, broader contextual themes that I see in terms of mistakes with retirement accounts comes just from this general lack of understanding about what they should be used for, and how you should plan around them. To your point about withdrawing early, to me it doesn’t make sense to ever withdraw early and incur the penalty from retirement account. To me that says bad planning, and not having a strong general financial foundation. And to give you the idea of why this is such a problem, suppose that I have $100,000 in my retirement account, and I want to withdraw the entire balance. Well, several things are going to happen, first… and let’s say it’s a 401(k) tax deferred. First, I’m going to realize that money is income. So, I’m going to pay taxes on that realization of income. I’m also going to pay a 10% early withdrawal penalty, and I can’t quite remember if that penalties is assessed before after taxes. Do you know that, Mindy?
Mindy: The penalty for early withdrawal is assessed before taxes. So you take out $50,000, you are assessed a $5,000 10% penalty, and then you pay taxes.
Scott: And then you pay taxes, and you’re realizing income. And the reason why realizing that income is such a big deal is because during your working career, you’re likely to be earning or realizing more income. You’re realizing more income and income at a higher tax bracket. A higher taxable income, then when you reach retirement age and withdraw only with that what you need. So, you’re kind of taking a double whammy in many cases if you’re going to be withdrawing that money early for unforeseen event.
Two other big mistakes before we move on from retirement accounts. One, not understanding the fee structure in retirement accounts. I think a lot of people automatically enroll in these accounts and they enroll in the recommended plan, whatever, by the provider. That may not be the plan that has the best fee structure to give you the highest probability of building long term wealth in your portfolio. We’ve talked about it before. We’re a big fan of index funds or funds that have low management fees that closely trail market indexes. There’s a lot of good research out there indicating that these actively managed funds tend to underperform after fees relative to passively managed index funds. Not to say you can’t do that, just make sure you understand the difference in what you’re getting into. It goes back to what show is-
Mindy: Episode 20 with Jim Collins.
Scott: Okay. Episode 20 with in Jim Collins. Yes, go back and re-listen to that if you want a better understanding on that concept. Then third, not taking free money. There’s a match when it comes to 401(ks) with many employers.
Mindy: There can be.
Scott: Yes. Well, many employers will offer a match, and if you’re offered a match, particularly one that vests very rapidly, then that can be a really good source of capital. It’s going to be very difficult to double your money, basically instantaneously in a lot of other investments. Even if you do have high fees that you’re investing that money in, you can always roll it over at a later date.
Mindy: Yep. And I’m going to go one more with retirement accounts and say if you are a, is it government or state employee? If you have access to a 457 plan, absolutely max that out before you start maxing out any of your other accounts. The 457 plan is like the public employees’ 401(k). But they also have access to a 401(k) or can have access to a 401(k). So if you take your money, and you put it into your 401(k), you can’t access it until you’re 59 and a half, unless you want to pay fees and penalties and all that. But if you put it into a 457 plan first, you can take that out when you separate from employment at whatever age. There’s no fees, there’s no penalties, there’s no taxes. I don’t recommend taking it out. But if you need funds, you can access those funds first without any penalty, which is better.
Scott: One last thing on retirement accounts before we move on to the next topic here. I’ve said in the past that I preferred personally not to max out my contributions to retirement accounts. Particularly at the beginning of my career, because I thought that having that liquidity available after tax would give me more… in a account that I was willing to spend to fund my lifestyle, or invest opportunistically was more to my advantage than putting that money into retirement accounts. I currently be clear max out my retirement accounts. And that’s because my career has gone a good trajectory, and I’m able to max them out and have more cash incoming than great opportunities to invest in right now, which is a great problem. But Mindy, what do you think about that approach? Do you think I’m crazy? A lot of people do.
Mindy: No, I don’t think you’re crazy. I thought you were crazy for not maxing it out when you were younger. I remember having several conversations with you earlier in your career not maxing out your 401(k). It worked out for you, and you specifically have a very logical mind. And you could see that if you saved your money for a down payment on a house, you could then move in house hack, you didn’t just buy a great big house, you were saving for an investment property that you could also live in, and were you putting anything into your 401(k) at the time? [crosstalk 00:46:56]. Or maybe you didn’t have…
Okay, so I am looking for ways to reduce my taxable income. I’m always looking for ways to reduce my taxable income to zero because I like paying zero taxes. But I’m currently paying more than zero. So, maxing out my 401(k), maxing out my HSA are ways that I reduce my taxable income. I’m also a little leery about the stock market right now and have a sizable portfolio in the stock market. I have to wait until next year before I can pull more money out and not pay capital gains taxes on it. So, I just have to sit here and wait in our interesting… What’s interesting going on in Washington DC right now, and Wall Street does not like political instability. So, I’m expecting and not predicting, and don’t pull all your money out and then say that I cost you a bunch of money, but I am expecting some volatility in the stock market.
Scott: The next recession is always 12 to 18 months away.
Scott: But the research is backing that up. Every year they predict recession 12 to 18 months away.
Mindy: Okay, I think we’ve done enough about retirement accounts. Bottom line is put it in and don’t take it out.
Scott: All right. So, let’s go to spending. Generally, this is outside the big ones of housing and transportation here. But you know, I think the biggest mistake people make when it comes to spending is simple. It’s not tracking their spending. I would say 40 to 50% of our guests said that the number one piece of advice for people who are just starting out is to track your spending, and we couldn’t agree more. I think that would be our number one tip me and you for anyone trying to get their financial journey going.
Mindy: I’m going to plug the Waffles on Wednesday Mobile Spending Tracker again. We use that, my husband made it up. It’s a Google Form that you put a link to on your phone or mobile device or you can remember to do it every night, good for you, but I can’t. I put it on my mobile device. Every time I spend money, I open that up, and I write down where I spent it, how much I spent it, what it was for. Yeah, that’s basically it. But it helps.
When I know I have to write it down, and I know that I have to show my husband that I’m spending this money, I’m more conscious about what I’m spending simply because it’s very easy to get out of hand. And when I say I know I have to show my husband, he’s not tracking me. He’s not harping on me to, “Oh, why did you spend that much money?” It’s just, it’s so much easier to say I spent $40 on groceries than I spent $40 on groceries and also $100 at Target on two shoes. I don’t need them. I already have other shoes. According to him, I always need more shoes, but-
Scott: You’re on the same team.
Mindy: We’re on the same team. Exactly. But I want to be on the winning team. So, I want us to win the spending choices. And do you know what, this weekend we went out to dinner three times because we’re working on the new house, and we had a lot of crazy stuff going on. But it’s okay because we can handle that financially. If we couldn’t, then we would go home and make dinner and slog through it.
Scott: Yeah, absolutely. Once you’ve tracked your spending, and whatever method is the best for you. The next piece is analyzing that spending, and sitting down and looking at where’s my money going? And if you take a look at the average person, two thirds of their spending is in housing, transportation, and food. And really, that is probably what your budget should look like, and how do I make progress against it? How do I reduce my housing costs? How do I reduce my transportation costs? How do I reduce my food costs? How do I maintain my quality of life while cutting back on expenses there?
If you find that you have a major line item in your budget, like dining out, or shopping for shoes, that is a major piece of your budget, then you need to assess that. Did I know that was the case? Am I consciously doing that? Or is that something I can make progress on because everybody’s different. Only by tracking your spending and analyzing it can you find out what those additional leverage points are in your life and your budget.
Mindy: Yep. You don’t have to change everything all at once. I know that I have told this story before, but I’m going to tell it again because it’s my real life example. When we started tracking our spending, I discovered I was going to the grocery store literally every day. I just needed one thing or two things. But when you go in for one or two things, you come out with five or 12. And once a week is fine… Maybe not fine that not such a big deal. But when it’s every single day, those things start to add up, your purchases add up. I don’t need to go to the grocery store every week, I just need that one ingredient. No, you know what, makes something else. Go to the store and pick up that one ingredient when you’re there for other things. You need milk, you need food, but you don’t need turmeric, you can just skip it or make that recipe another time.
The Steve & Annette Economides, the world’s cheapest family goes grocery shopping once a month or something. It was a How To Cut Your Grocery Bill In Half. I can’t remember the name of the book. I’ll look it up and I’ll put it in the show notes which can be found at biggerpockets.com/moneyshow93. That book changed my shopping life because they go to the grocery store once a month. I don’t go to the grocery store once a month, I go more frequently. But that was amazing that you could just plan ahead and reduce your spending, reduce my spending tenfold just by tracking my spending. We weren’t even going out to dinner that much. We didn’t have a lot of other expenses. But the grocery store was eating up every dollar we had.
Scott: No, I think it’s a great example. Another good example for me, every time I do this, and I should do it every month. I do it once a quarter. I always find, I signed up for this subscription somehow, and it’s going from last year or from last month, and I don’t use it anymore. And I can cancel it just by tracking, by looking at my accounts. It’s got to be $1,000 a year across those types of things that I’m able to save.
Mindy: Yeah. Oh yeah. I’ve got… As soon as you said that I’m like, “Oh, I have a subscription I need to cancel.”
Scott: Nice. All right. The last category here before we close out the show here is some of the big mistakes people make around investing as a broad concept. All right. The last category of financial mistakes to avoid here, these mistakes around the concept of investing. I think that if we go back to Episode 86, with David Stein, that he said something that really stuck out to me is that you need to be able to understand and articulate exactly what it is that you are investing in. And if you can’t do that, you maybe shouldn’t really be investing in that asset.
Mindy: Not maybe, you should not be investing in that asset.
Scott: That’s right. Yes. Thank you, Mindy.
Mindy: I’ll be very forceful with you. I can’t explain Bitcoin. I don’t want to, I don’t care about it. I don’t find it a viable… I mean, and that’s the one that I always throw under the bus, and I don’t care because I don’t like it. So, I will throw it under the bus. You can send me an email at [email protected]
Scott: I always like to quip at that point that I do understand Bitcoin and cryptocurrency and that is exactly why I do not invest in cryptocurrencies or Bitcoin. But the answer is, if you can’t explain why you are investing in something, and are not very clear on that rationale, I think you’re going to be in big trouble at some point, and you’re going to lose a lot of money. That comes from everything. You probably hear a lot of people talking about index funds. But the answer is not to go in and just blindly invest in index funds, either. It’s to go out and understand exactly what an index fund is, and why a lot of people suggest investing index funds as an alternative to investing in individual stocks, or actually actively managed funds.
If you can’t articulate those differences, and your approach to financial freedom is based upon the rationale for investing in index funds, you’re in trouble, and you’re going to have some problems. So, it’s self educate and understand what you’re investing in.
Then the second point that I’d like to make around investing, after understand what it is you’re investing in, is to invest from a position of financial strength. Conversely, the mistake here is investing from a position of financial weakness. If you are investing, and then you need to access that money for a let’s call it typical life problem. You know everyone should have health insurance. If you get in an accident and need to go to the emergency room, and have an $18,000 out of pocket expense for that, and that’s going to cripple you and force you to liquidate your investments, you’re not investing from a position of financial strength.
You need to be able to whether the storms of that are typical, more or less that everyone’s going to experience, or many people are going to experience over the course of a lifetime before you invest, so you don’t have to sell your rental property or sell your stocks. Because when you’re investing, at least the way we typically talk about it, it’s typically for the long term. And if you’re forced to sell, you can ruin what is otherwise a good philosophical approach to investing or specific investment, that was a good one with a good rationale.
Mindy: And when you’re forced to sell, typically you’re not selling at the top of the market, or for top dollar, or for the best terms, it’s typically a fire sale, and you’re just trying to grasp whatever you can. I see frequently that you’re selling and breaking even. Maybe even making a small return on the positive end, or making a really bad return on the negative. Remember in 2008, 2009, 2010, people just fire sold their properties because they couldn’t afford to keep them. We live in an area with there is a thriving vacation area not too far away from us in the mountains, the ski resorts and things like that.
I remember coming out here and looking at the properties. All my money was tied up in one property that I was flipping that was my own personal disaster, with multiple exit strategies. So, I didn’t have to sit there and sell it for nothing. But up in the mountains, there were lots of properties. And I saw one it was like $400,000. It didn’t have a kitchen, but all the cabinets were in the garage. It needed appliances, it was easily a million dollar house that needed $100,000 worth of work, but it had to be a cash offer. You had to close within two weeks, and I didn’t have it. I’m sad for the people who were losing it. I’m very pleased for the person who was able to get it, but it was definitely they were losing a lot of money on that house.
Scott: In real estate investing, we call that a motivated seller. If you invest from a position of financial weakness, you have a very good chance of becoming a motivated seller and producing a great deal for a real estate investor investing from position of financial strength. Similarly, when you are a homeowner or a real estate investor and you own a property, and your tenant trashes the place and you have to spend $8,000 repairing it. This is a real life story. Some people, the unprepared investor who has no savings and is barely breaking even on the property is going to call that, use a term disaster to describe that situation. I had that situation, and for me, that situation was called a capital expenditure. There’s a big difference between the two, and it’s because I’m investing for position of financial strength when I can whether those storms and they’re expected. This is part of life.
I expect over the next 20 years, 30 years, 50 years, 70 years, the rest of my life that I or my future wife, fiance, or one of our future children is going to have a problem, a medical problem or some sort of thing, like an accident that I’m going to have to shove out cash for. Those are the expectation you have to have in life. Investing is after we’re covered from those things. Investing is for the long term.
Mindy: Yep. Oh, that’s perfect, Scott. Okay. Scott, do we have anything else we want to add before we get out of here? This has been, I think fairly all encompassing.
Scott: Yeah, I apologize to everyone. I got going at the end there and started ranting, but hope it was helpful.
Mindy: This is our show. We can rant all we want. Okay, so this week’s question is what financial mistakes are you seeing people make and how can they avoid them? How do you think they can avoid them? Like we said last week, we’re starting a new thing where we will ask a question on the show that we release on Monday and we will record a video with your answers and release that on Friday on our YouTube channel. So, if you would please send your answers to [email protected], that’ll be fantastic. Scott.
Scott: I’ll add in you can send them to [email protected], and [email protected], and they might also get released on at least my Instagram, scott_trench @scott_trench. I’m not sure if you’ll be doing a social media as well. But-
Mindy: Yeah. Absolutely. I have a Instagram account at MindyatBP M-I-N-D-Y-A-T-B-P. And yes, Scott, I am going to be releasing these videos on the Bigger Pockets Money Instagram account, which is at Bigger Pockets Money.
Mindy: Okay. From Episode 93 of the Bigger Pockets Money Podcast, I am Mindy Jensen, and he is Scott Trench, and we will see you on Friday.
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