Is Scott Trench Wrong? Retirement Plans vs Real Estate

Cole Hagen · 2017-07-06T08:38:50-07:00

I just finished Scott Trench's book "Set for Life" and let me start by saying it is a awesome read and I fully recommend it to anyone and everyone.In the book Scott bashes on typical retirement plans such as roth IRAs, 401k plans, and etc. and considers them a foolish investment that majority of Americans fall victim to every day. (he does dive into this idea more in the appendix about to take advantage of retirement plans properly and does not bash them completely but this is not the point of this post). I want to give two scenarios and get the opinions of others about which way is more effective at reaching financial independence. 1.) For example, I am 22 years old with a college degree and an above average income of 55k a year (very similar to the income range Scott references in his book). Unlike many of my peers, I worked through college, lived at home, and currently have no debt to my name. My company offers a 100% 401k match that can either be a traditional or roth. The only thing is that if you choose roth 401k then the match will be put into a separate traditional 401k. With the max individual 401k contribution at $18k/year, I could potential put in 18k/yr and match 18k/yr from the company combining to a total savings of 36k/yr. I have learned that 401Ks throughout history have returned 8-10% (obviously with some variance and this post isn't to argue this return). From a simple spread sheet and figuring a 8% annual return on a 36k annuity, I would have roughly 773k in 13years which would return 54k per year and would be "financially independent" based on my current salary as this would yield $61,900/yr in interest minus the 10% early withdrawal penalty.The downfall with this approach is that if I max this plan out then my take home pay is largely cut and hurts my ability to save and invest in real estate (which is my ultimate goal)2.) Do not contribute to the 401k plan and save 15-20k per year to purchase buy and hold rental properties?*I am stuck between these two because I understand all of the upsides of real estate investing but I see and immediate 100% return on my 18k/year "investment" with the 401k not including the 8-10% return the market could bring. I would love to hear peoples opinions on these approaches as my plan will start in 2018. I would also love to hear Scott's opinion on this (so fingers crossed that he reads this) as I am a full believer that people in general and especially millennials like myself are very under-educated in the subject of personal finance.

Steve Miller

Rental Property Investor · Golden, CO · Member since 2017 · 19 posts · 57 votes

9y

There is also an element to this diversification discussion that has not been brought up, which is the ability of that diversification to functionally serve as a backstop for risk.

The most powerful tool that younger investors have working in their favor is leverage. How aggressively a given investor may want to use that leverage is a matter of their personal outlook/propensity for risk/current life status. For example: would you take out a 95% LTV HELOC on your primary residence to fund a deal you felt confident in? How would your mindset change if that was the entirety of your net worth? How would the conversation change if you had a family? Some people would, but I wouldn't.

Consider the same situation now coming from a well diversified position (perhaps penalized, but still liquid). You may feel more comfortable moving aggressively on that deal if you knew you had a backstop of 10s or 100s of thousands of dollars elsewhere. My point in all of this is that risk (especially with regard to leverage) is personally subjective. If the money from an employer is free, take it! Even though it may feel like that money is dead (it's not) compared to the returns you would see in real estate, it also gives you the gift of being able to use leverage more responsibly.

1 Reply

Josh Gold

Investor · Newberg, OR · Member since 2016 · 22 posts · 12 votes

9y

@Cole Hagen as you continue to calculate the implications of this, be sure to calculate the increased tax bracket that you will be thrust into when withdrawing $773k. You will not only have to pay the 10% penalty but you will also have to pay taxes in the highest income tax bracket.

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Linda WeygantPro Member

Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes

9y

Back when I was employed, I maxed out my company's match (6% of my salary) in the 401k program. I also maxed out the contribution to the ESPP (50% of salary), because an immediate sale of the stock each quarter gave me a quick and easy 20% return.

This meant that I was bringing home peanuts in my paycheck every other week. Literally my very comfortable paycheck went down to a few hundred dollars each pay period. I had a little tucked away in savings during that first quarter, but when the end of quarter ESPP transaction hit, it was enough to replenish the savings and start ahead for the next quarter. I did this for about 18 months before leaving the company.

There were several financial factors involved in my leaving - this was not the only strategy that enabled me to leave employment. But it certainly helped.

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Linda WeygantPro Member

Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes

9y

PS - I wish Scott's book had existed when I was in my 20s, but I don't think that Scott himself existed at that point. Knowing what I know now, I'd follow his advice. I feel like I'd be so much closer to my goals had I made drastically different choices when I was younger.

The market is right, the time is right, the social and political climate is right for the advice in Scott's book. If your company doesn't match your 401k, I personally would still put a little in (no more than 2% or 3%), just to have some diversification when you're older, but the advice to skip it altogether and focus on where you get better returns isn't bad advice.

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Mike S.

Rental Property Investor · Huntsville, AL · Member since 2013 · 419 posts · 323 votes

9y

Originally posted by @Anthony Gayden:

Cole Hagen

You are forgetting that you can't touch that 401K money for a very long time. It is stuck there until you hit retirement age.

It doesn't matter if you are a millionaire at 35 if you can't touch that money for 30 years.

You are at the mercy of some company executives who are making real profit on the money you have stuck in that 401K.

Sorry, it does matter if you are a millionaire at 35 in a 401k. Having assets in my 401k has provided me access to loan products and special consideration at my local bank. My Banking Financial Statement shows me as a millionaire and has opened resources to me that I would not have otherwise.

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Eric Hardt

Oak Lawn, IL · Member since 2017 · 29 posts · 20 votes

9y

As others have said, you should definitely be taking the 100% match on the 401k. 18k in free month can't be beat.

I had previously worked for a company that had matched $.40 on the dollar with no cap, so received matches of 7,000 and later 7,200. My thought process was pretty simple in that even if I withdrew money from that money, it was still a pretty fantastic return. Without factoring in vesting schedule and any annual return, I'd still have 22,680 based on my 18,000 investment after paying 10% penalty, but before income tax. Yours would obviously be better.

As much as you would likely enjoy a $8M plus dollar portfolio in retirement by investing 36k a year, it's quite a bit more than most would need.

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Paul S.

Suburbs, OH · Member since 2014 · 26 posts · 3 votes

9y

You can also take a loan out of the 401k generally up to 50% of the value and repay up to 5 years with the interest actually paid to yourself, so it's a handy way to reduce taxable income and provide a source of funds for down payments.

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Michelle Rosado

Brooklyn, NY · Member since 2017 · 2 posts · 0 votes

9y

I didn't see a mention of the fees that one pays to invest in a 401K. Is it worth it being as avg fees are 2.5% and the avg rate of return is 7%? You are actually only earning 5.5%. Over time that eats away at the money you need for retirement. Why bother with a 401k?

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Account Closed

Houston, TX · Member since 2015 · 37 posts · 20 votes

9y

Michelle Rosado I've anecdotally heard of pervasively high 401k fees, but I am admittedly uneducated on what is typical for the market. My employer's 401k fees range from 0.02% to 0.08% depending on the fund but that's obviously a single data point. Is the typical fund's fees really as high as 2.5% or is that more an outlier? Not arguing, it's an honest question.

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Michelle Rosado

Brooklyn, NY · Member since 2017 · 2 posts · 0 votes

9y

Yes as I've learned, there are normally Plan administration fees, Individual service fees, Investment fees. Add that a number of fees that fund managers are not legally liable to disclose. Investors should not assume that all they are paying for their 401k is plan administration fees.

John Bogle discusses this in the PBS film " The Retirement Gamble" and Andy Tanner in his book "401Kaos" just to name a couple.

I know 401k plans work for these employers but I would love to know if a 401k is actually working for the participants here.

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Mike S.

Rental Property Investor · Huntsville, AL · Member since 2013 · 419 posts · 323 votes

9y

Originally posted by @Michelle Rosado:

I didn't see a mention of the fees that one pays to invest in a 401K. Is it worth it being as avg fees are 2.5% and the avg rate of return is 7%? You are actually only earning 5.5%. Over time that eats away at the money you need for retirement. Why bother with a 401k?

I imagine no one mentioned 2.5% fees because you'd have to work for a piss poor company if you're fees are that high. I don't think there is a fund in my 401k over 1% with most at .5 to .75%.

1 Reply

Pete Fiannaca

Wholesaler · Henrietta, NY · Member since 2016 · 58 posts · 27 votes

9y

If the match is 100% up to the current federal max, then I would be maxing that out for sure. Even if you take cash out early, the 10% penalty is peanuts compared to the "bonus" match your company is providing.

Something else to think about... If your 401 provider let's you borrow against your plan, then it sounds like after 5 years or so, you'd have a nice little line of credit in the making.

2 Reply

Kevin Phu

Rental Property Investor · San Diego, CA · Member since 2016 · 507 posts · 171 votes

9y

I find having a Thrifts Savings Plan (gov't equivalent of 401k) to be very helpful for me. Why?

1-My contributions are tax-deferred

2-My agency matches my contributions up to to 5%. 100% of first 3% and then 50% of the remaining 2%

3-I can take out a TSP loan to use towards a home purchase and since all my contributions are tax deferred, that amount can be built up faster than putting away taxed income.

I don't max out my contribution right now as I like a to make sure that I have a large amount of liquid cash on hand as well.

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Joe SplitrockPro Member

Moderator

Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes

9y

@Cole Hagen always take advantage of company matching. You are instantly doubling your money.

Stock market returns historically around 7% when you adjust for inflation. Keep in mind that is a long term average and assumes an index approach. It has also lost as much as 40% in a single year. The best market strategy is to find a low fee whole market index fund and continuously invest, good or bad market. Set it and forget it and you will enjoy a 7% return for doing pretty much nothing.

Your situation is even better, because you will have a 100% return your first year guaranteed. That basically doubles your returns to 14%. Just be careful to invest in a whole market index that has low fees, like well under 1%. Don't try to guess at individual stocks or let someone convince you that their mutual fund outperforms the market.

I always max out my Roth 401K because of the tax advantage. I also like retirement accounts because they are protected from bankruptcy. I do own some individual stocks in a separate account, but that is mainly just for fun.

Most of my money goes towards rental properties, so for me it is not one or the other.

I have not read Scotts book. Just because after listening to the podcast interview, it sounds elementary to where I am at. Nothing against him or the book. He has gotten great traction in a short period of time.

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Mike Dymski

Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes

9y

Good advice on taking the match and please please ignore the misinformation on high retirement plan fees for all plans and the inability to withdrawal all types of retirement funds prior to retirement. It's amazing that nonsense shows up on an investing site and that people would also turn down a 100% match to avoid a 10% penalty...incredible.

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Scott L.

Investor · Flower Mound, TX · Member since 2017 · 182 posts · 198 votes

9y

I think these 401k admin fees of 2.5% are rare. If you're employer uses Fidelity or Vanguard or a number of other large plan managers, you're usually only paying a few basis points. If you put your money in large no load funds or etfs you pay 25 bps 0.025% at the most. Where are these companies secretly burying the 2.5%. My employer just started charging an admin fee a couple years ago... $10 a quarter flat. I consider that $40 reduction in the $8000 that they match per year. Actually $10,000 since I turned 50. Unless your 401k is in some crap no name fund company that charges a 2.5% fee on all their funds you're not losing that much to fees. What about the money market funds that only pay 1% or less? Do they subtract from your balance every month? If you don't take the match at your company, you're throwing away free money (do consider vesting schedule, but all YOUR contributions are 100% vested immediately....)

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Marshall Easlick

Investor · Wellington, CO · Member since 2017 · 79 posts · 30 votes

9y

@Cole Hagen @Karen O. Karen O. brought this up and I am surprised that no one else asked it (or maybe they did and I missed it) but, how long does it take to get vested in your company's 401K? If it takes 6 years to be vested and you don't think that you'll be with the company for 6 years, then contributing to their 401k doesn't mean much.

I worked for an oil and gas company that required 6 years of employment with no more than 6-month gaps in that employment in order to be vested. The oil fields are so cyclical and unpredictable that I knew I would be laid off for more than a 6-month period before I reached that 6 years, so I didn't even bother with their 401k. I now work for a different oil and gas company that only requires 2 years to be vested and I started with them when the oil fields started to recover, so I took the bet. I am currently contributing to their 401k because I think that I will be employed by them for 2 years before I get laid off. I am not maxing out my annual contribution but I am contributing enough to max my company's match (5%) because it's free money that I will probably get and I plan to create a self-directed 401k.

I am sure that you are in a different employment situation than I am but this is how I decide whether or not to contribute to an employer's retirement fund. If there is little possibility that I will get the match money, then I will control my own money for investment. If I will probably see that money one day, then they can control it for now and I will use my 401k for note investing down the road.

1 Reply

Ian Covington

Investor · Hartselle, AL · Member since 2017 · 11 posts · 8 votes

9y

If it were me, I'd put in enough so that match at least meets the standard 10 percent saved. 401ks count when it comes to financing real estate, It gives you another option for cash flow streams, they are a bit more liquid than home equity, and you can leverage your contribution rate in order to avoid higher tax brackets. Remember, you can always pull the 401k out later

For funding investments outside of the 401k, I'd focus on reducing personal spending in order to reach those goals faster.

As an option to build funds when you are in that weird stage of not having enough to do anything with, you can invest it in high quality dividend stocks in normal brokerage accounts. This can help you "load the gun" a bit faster. Rather than having the cash just sitting there, let it earn before converting it into another investment. I did this and it worked out great for my first two properties and I plan to continue until I reach an income rate that I have enough to invest without collecting dividends and capital gains. As an example, I put about $9.5k in ATT and VZ and pulled it out upon being under contract with cap gains + dividends that came out to about $1100. I used Robinhood for this because it is commission free and you can buy it one share at a time if you want. Sure I will have to pay taxes, but it still beats letting it rot in the bank. The disclaimer is I spent about 2 years of self study in stock market investing. I knew the money was made before the purchase. If mastered, it can be a great way to keep your cash in constant motion.

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Thomas RutkowskiPro Member

Financial Advisor · Boynton Beach, FL · Member since 2015 · 834 posts · 798 votes

9y

I think your return and income expectations for your 401(k) are unreasonable. The market indices may perform at a 8-9% level, but the funds that invest in the stocks of those indices charge management fees that average 1.5%-2% for the industry. There is no evidence to support active fund management outperforming the indices. In fact, the un-managed indices tend to outperform 80% of managed mutual funds. Typical returns for a 401(k) investor will likely be 5-6% net of fees. All of this is backed up by plenty of industry research.

The common rule of thumb for income used to be the 4%-Rule. According to the 4%-Rule, you should be able to withdraw 4% each year and your portfolio should be able to keep up with inflation and ride the ups and downs of the market without running out of money before you die.

4%-Rule analysis

4% on a $1 Million 401k is only $40,000. And if it is a traditional 401k, your withdrawals will be taxed as income. Your $40,000 withdrawal could be only $30,000 if your effective tax rate is 25%.

1 Reply

Joe SplitrockPro Member

Moderator

Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes

9y

Originally posted by @Thomas Rutkowski:

I think your return and income expectations for your 401(k) are unreasonable. The market indices may perform at a 8-9% level, but the funds that invest in the stocks of those indices charge management fees that average 1.5%-2% for the industry. There is no evidence to support active fund management outperforming the indices. In fact, the un-managed indices tend to outperform 80% of managed mutual funds. Typical returns for a 401(k) investor will likely be 5-6% net of fees. All of this is backed up by plenty of industry research.

The common rule of thumb for income used to be the 4%-Rule. According to the 4%-Rule, you should be able to withdraw 4% each year and your portfolio should be able to keep up with inflation and ride the ups and downs of the market without running out of money before you die.

4%-Rule analysis

4% on a $1 Million 401k is only $40,000. And if it is a traditional 401k, your withdrawals will be taxed as income. Your $40,000 withdrawal could be only $30,000 if your effective tax rate is 25%.

Exactly and even the mutual funds that do outperform an index are all new. Once a mutual fund has bad performance, they just cap new investment and start a new fund. That way they can always show "good performance".

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Peter MckernanBusiness Member

Residential Real Estate Agent · Irvine, CA · Member since 2013 · 2k+ posts · 1k+ votes

9y

@Cole Hagen I believe if there is a match possible to make sure that you hit the match at your work, even if that means reducing the income that you would be able to save for retirement. The reason I say this is because your earning potential is so very great at your age.

You as a young man can create the ability to have that upwards mobility in your company to quickly move up in the income as a employee there, which will increase your income and allow you to save for an investment property.

The other possibility would be to work at your full time job and create a side income to increase your earning power and save all that money towards a property. These could be working as a wholesaler, flipper, or real estate agent (many more options than that though).

In the end, I believe your retirement account that they have given you the opportunity to have is a large on, so take it and work hard in another area to create a higher earned income!

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Mike Hottinga

Lake Havasu City, AZ · Member since 2017 · 58 posts · 23 votes

9y

I read Scotts book about a month ago now and I have to say being 27 that it has completely changed the way that I look at my personal finance situation. I now keep track of my personal finances like a business, inputting everything in to a spread sheet that I created. I do this so I can see where I am spending to much and where I can save. Like Scott described in Set for Life I am making cuts to by budget that will make a real difference with out hating it, like saving $50 on entertainment (decrease in life enjoyment) vs finding my 2 roommates and cutting my mortgage from $1250/month to $150/month and cutting utilities to a 1/3 for me. That money is now available for me to invest else where to build wealth, not just to buy more things.

Employer:

My company matches 4.5% of pretax income for 401K, I contribute 5% currently. My company offers a 457 plan that I plan to bridge some of the gap between retirement from my employer to working for myself, hopefully managing my real estate business. I contribute 5% to this account. I have both of these accounts invested with Vangard in various index funds (very low management fees) and a bond Index fund. This capital has also allowed me to obtain financing on my first SFR that I am now house hacking.

Personal:

I opened a Roth 401K account and max it out every year (5500 limit). After 5 years I can pull the principle out at any time and use it to invest with without penalty.

I am loading my savings with "dry powder" so I with have the capital to take advantage of future opportunities when they present them selves. Beyond this, I am not sure what I will do with the money, but what great problem to have.

I have read 4hr Work Week, Set for Life, and Millionaire Next Door since June and I feel I have accomplished more in the 2 months since I have read these books than I have in the previous 5 years. If I had not read his book, my plan A for life would be just like every one that I work with, work 40hr weeks till I am 55-65. Now my goal is to be financially free ASAP and go on my own path.

1 Reply

Joe SplitrockPro Member

Moderator

Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes

9y

Let's try a mathematical simulation to see if @Scott Trench is wrong.

Lets say you have $20,000 and buy a $100,000 rental property using banks money. For comparison, that $20,000 could be matched to be $40,000 and invested in the stock market.

Stock market index fund, $20K invest plus $20K match ($40K total) at 6% annual return:

Total stock market at the end of 20 years is $121,024

Rental property $100K, $20K down payment, 20 year loan at 4.5%:

Property value at 3% annual appreciation, paid off at end of 20 years is $175,350

Rent collected at $1000 per month, 3% annual increase, after 50% expenses and mortgage payment of $500 over 20 years is $64,022

Total rental property at the end of 20 years, net rents plus property value is $239,372

The results are very interesting. In my simulation you end up with around double what you would even with company matching. It is around four times without company matching. If you change the simulation and assume NO appreciation of property value and NO rent increases, it still works out that a rental property a better investment by over a $1000 at the 20 year mark.

The reason this works is leverage. Your company matches 1:1, but the bank matches 1:5. Rental property offers multiple income streams:

1. Mortgage pay down / equity building

2. Property appreciation

3. Rental income

4. Tax advantages

Based on my calculations, Scott Trench is right. Even with 100% company matching, it is still better to invest in rental properties. Even assuming the property and rents have no appreciation.

1 Reply

Scott Davidson

Accountant · Bethesda, MD · Member since 2017 · 63 posts · 34 votes

9y

@Joe Splitrock A couple items on the analysis. The 20k is not equal. One is pretax, one is post tax. Additionally, the average return on S&P is 7% and the S&P averages a 2% dividend payout.

Another consideration, actively managed or property manager? I ask because one is truly passive and I think we all know rentals are not 100% hands off.

Other points of consideration are risk adjusted return and exit value as well taxability over the lifetime of the investment. The rentals may or may not be a taxable write off depending on income.

All this is to say that I think there are too many variables to get an accurate picture of which is better or worse based on a financial analysis. We could all quibble all day on some of the variables.

As a hedge, if I was able to get a free $18k a year, I would take it. If saving the $18k/year precluded me from investing in real estate, I would do a deeper dive. As others have said, there's no reason not to do both.

2 Reply

Account Closed

Specialist · San Antonio, TX · Member since 2012 · 865 posts · 351 votes

9y

There is a Big difference between a Dave Ramsey mind set and aggressive real investor. Some folks enjoy writing so that is their riches/ reward. Never mind they they don't have the income to back up thier theory. Whereas the owners/ operators of Biggerpockets makes money from traction on the site folks that like to write can go along way in making a large splash even without a strong track record. ( No names mentioned) ;)

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Is Scott Trench Wrong? Retirement Plans vs Real Estate

Is Scott Trench Wrong? Retirement Plans vs Real Estate

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