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Posted about 8 years ago

Put yourself in a better position to take risk

Friends and family often come to me for advice on personal finance topics. I find it to be an honor and always try to find time to sit down and talk. Usually it relates to their mortgage or a decision to buy, sell or refinance their home. These are easy conversations that are generally 60% math and 40% emotion.  Let's breakout the HP 12c and figure this out!

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Other times the question involves the desire to start investing. They have decided that they want to getting to a different place in life. Whether it relates to low job satisfaction or the underlying stressful feeling of never getting ahead, the conversation is usually more likely to be 20% math and 80% emotion. 

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I always begin and end the discussion with the concept of every month putting yourself in a position to take a little more risk. The rewards are slow at first, but the positive momentum will eventually snowball into bigger and better opportunities. 

Ask yourself if the following could be possible if you supplement your career with real estate investing? It will take discipline, but this is not unrealistic.

Potential Goals - All In 2015 dollars

Age 27: Pay off all consumer debt, including education loans and have $10,000 maintained in liquid funds.

Age 30: Own two or more rental properties. Generating income from three or more income streams. Rentals contributing around $4,000 a year after debt service.

Age 35: $50,000 in cash reserves. $50,000 in stock and bond investments. Own four or more rental properties. Rentals contributing around $10,000 a year after debt service.

Age 40: $100,000 in cash reserves. $100,000 in stock and bond investments. Own 10 or more rental properties. Rentals contributing around $20,000 a year after debt service.

Age 45: $100,000 in cash reserves and $150,000 in stock and bond investments. Own 20 or more rental properties. Generating income from four or more income streams. Rentals contributing around $50,000 a year after debt service.

Age 50: $100,000 in cash reserves and $300,000 in stock and bond investments. Own 30 or more rental properties. Rentals contributing around $75,000 a year after debt service.

Age 60: $100,000 in cash reserves and $1,000,000 or more in stock and bond investments. Own 60 or more rental properties. Rentals contributing more than $150,000 a year after debt service.

With smooth and steady investing, you can consider early retirement because you will have a nice stream of income from the rentals as well as income from your investment portfolio. Additionally, you will also have significant equity in your rental portfolio so you can either enjoy the additional income because you will have less debt service or you can sell a few properties to reduce your head and expand your liquidity. This all sounds exciting, but what stops people from making it happen? No matter how you slice it, it's hard to make a change in your life without taking some risk. These conversations are more emotional because they always boil down to three things:

  1. Spending choices
  2. Relationship dynamics
  3. The willingness to explore additional income options

1. Spending choices - If you are living beyond your means and are not currently saving each month then you are not going to be able to take much risk. It usually doesn't take long to find the root causes. The usually suspects include having more house then what is needed, a nicer car than what is required, and problems in the discretionary spending category such as nice vacations, dining out, and fashionable clothing. I am not trying to demonize these things as I am no angel. However, it is a hard realization for some to acknowledge that perhaps the shiny Lexus purchase was more based on keeping up with the Jones then it was the best choice for the family finances. The premium leather seats will only provide temporary comfort as you drive to the job you find unsatisfying! The solution is to spend a few minutes on the math involved for a budget and then spend several hours talking about priorities and long term goals.

2. Relationship dynamics - This issue can be multifaceted with several people involved. Key stake holders may include significant others, children, parents, sibling, and close friends. Consider some of these emotionally charged scenarios. A spouse wants to go back to school to get a degree that will only result in a low economic reward and will incur some debt along the way. One spouse wants to have four kids and the other would be fine with just one. Adult children are still living at home and are not fully contributing. There is pressure from family to live near aging parents, but there are limited opportunities in the area.

Similar to the spending choices issue, the best cure for relationship challenges is to foster open and honest conversation with all involved. You will only be able to start taking more risks if everyone is on board with the long term plan.

3. Generating Additional Income - A lot is made out of saving more from the existing household budget. The problem with this mindset is that the net gain from savings is really limited to the amount you are earning overall. It is tough to start savings a couple thousand dollars a month if you a only making a couple thousand per month. Because of this, the best route is to explore other sources of income. Real estate investors definitely get this point, but real estate is not the only or best side hustle for all people. This might mean working more with your current employer, a second job, an online business, or freelancing. This can also be an emotionally charged topic as it might mean less time with family or working during non traditional times. Again, honest conversation with all involved is the best route.

How to measure your ability to take risk:

This is both a qualitative and quantitative exercise as risk tolerances differ from person to person. Ultimately, each person must make this determination based on individual situations, but I highly recommend obtaining professional feedback from a fee only financial advisor or an accountant. Here are some general guidelines to consider:

1. Maintaining cash reserves - How many months of living expenses do you have in reserves? Three months would be the bare minimum while some would argue for 24 months or more if you are planning on a big change like quitting a job and starting a new business. Keeping the funds in relatively liquid form is important.

2. Your ability to borrow money - Maintain a credit score above 700 is a good goal. If you have any commercial bank debt, be sure to understand the debt service coverage ratio required by the bank if applicable. This includes the ratio for the subject business or property as well as your personal debt to income ratio. You want to position yourself to be able to take on more debt if needed. At the same time you don't want to get a surprised from the bank because your income situation has changed.

3. Have multiple sources of income - Do you have multiple small income sources in place that could potentially grow if you allocated more time to them? Real estate investing is a common source, but doing side work from your primary job. Adding 25% to your existing income via new sources will go a long way in enabling you to take on more risk.

4. Having a written plan - Define your goals and the steps necessary to achieve them. Include proformas and contingency plans. Risk can be scary, but it is part of success. Taking lots of risk without thoroughly planning is just silly.

5. The ability to sleep at night - You may have the money to take the risks, but are you mentally ready for it? Whether it is the fear of the unknown or unsettled relationship issues associated with taking risk, you have to be prepared. If the thoughts of the unknown are causing you to lose sleep, then know that you may not be ready to take on risk. Meditation could be helpful. I personally use the Calm app to help me with guided meditation.      



Comments (7)

  1. That's a lottttt of money tied up in stocks and bonds, that would make me uneasy having that money tied up, but then again I don't know much about all that stuff, I only have a small 401K..


  2. Hi @Scott Scharl,

    Thanks for reading my post.  Be sure to check out my new post on liquidity.  It has been a busy summer, but finally got around to it.  Thanks for the encouragement.

    All the best,

    Mark


  3. Hi Mark! What I love about BP is that sometimes these slightly older posts surface and I get to see them. Loved this post -- thank you! This is very sound financial advice for people at every age. I think one of the biggest causes of stress for many people is the potential inability to survive a financial crisis. I hope everyone reads your post and starts making the necessary changes to put themselves on a path to financial stability!


    1. Hi Kent, Thanks for reading!  I am thinking about writing a new post about the importance of liquidity.  Real estate is a bit like going to a party.  If you show up early and leave early, you are generally glad about it the next day.  If you show up late and never leave, you might not feel good the next day.  I am not advocating liquidating your portfolio, but I am advocating potentially taking some gains on some houses that may no longer yield as much based on current values or perhaps liquidating a tired house that might be difficult to move during a recession.  Real estate investing is great because you can use leverage.  Flips are also a lot of fun and can have awesome returns, but are capital intensive.  However, liquidity (in terms of having cash as well as having properties that you can sell easily) is so important when things get rough.  We are not in 2007 yet, but we might be in 2005.  


      1. Hi @Mark Spidell, did you write that post about liquidity yet? I'd really like to hear about your perspective. Thanks for sharing your experiences on BP.


  4. Nice post. I liked the point about working on secondary income sources and increasing your income by 25%. At first, it may not make a major difference, but if continued for a couple of years, it could easily compete with your primary job. Further, investments in stocks, bonds, and rentals give you a diversified portfolio. Thanks for sharing! 


    1. Thanks for the note Dmitriy.  A lot of BP members are anti stock and bond market.  I agree to an extent as it can seem like the game is rigged.  However, the liquidity of those markets can't be ignored and diversification is powerful.  The real estate party is going strong, but there are a lot of new participants.  Those that are not prepared and end up in a liquidity problem.