I talk to a fair amount of baby boomers who are preparing to retire.
I’m often surprised how many of these individuals, including some very wealthy people, have no idea whether or not they have saved enough to fund their desired lifestyle through retirement.
You can hear the anxiety in their voices when they start going over the math, “well if we live until age 85, and earn 8% a year and take a 4% yearly withdrawal rate …we should run out of money a few hours before kicking the bucket.” I asked one such retiree, “Ok, but what’s the backup plan if you live to be 100”? He replied, “move in with the kids”.
This is a stressful and depressing approach to retirement planning. The golden years should be spent enjoying grandchildren, hobbies, traveling and beginning new adventures, not obsessing over retirement calculators and secretly hoping you pass peacefully in the night before the last check bounces.
Admit it, You Are Not Warren Buffett!
Many baby boomers will enter retirement watching the stock market like a hawk, walking around on cloud nine and taking numerous vacations during bull markets then panic and clip coupons during bear markets.
Furthermore, with a lot of free time on their hands, many retirees will get antsy and start trading based on short-term volatility. We’re all fooled into thinking that a little homework and thoughtful action will drive superior stock market returns.
Why Direct Real Estate Investing Is Ideal For Retirement Planning
The research shows the average investor would be better off buying and holding an S&P 500 index ETF. Of course, no one will admit they’re an average or below average investor, so they’ll listen to hot stock tips, ride momentum stocks, trade too often and erode returns with transaction costs.
These investors are their own worst enemy. They made their money through hard work and action, so it’s hard to accept that they can’t out hustle the market. But aren’t retirement savings too precious to be exposed to investors’ animal spirits and overconfidence?
1. A Buy And Hold Strategy Is A Lot Easier To Execute With Real Estate Investments.
You won’t be bombarded with real time price quotes on your real estate assets and Jim Cramer and other TV experts (charlatans) won’t yell in your ear to sell, sell, sell one week and then buy, buy, buy the next week.
Furthermore, real estate transactions move painfully slow. You can’t simply call your broker to dump all your real estate holdings during a moment of despair or after your buddy tells you the sky is falling and he’s moving his entire portfolio to Bitcoins.
2. Tremendous Tax Advantages:
You can shelter retirement savings via a 401K or standard IRA, but you’ll have to pay the tax-man when you start withdrawing.
With real estate you can take depreciation (paper losses) and mortgage interest deductions, which could result in tax-free cash flow until an asset is fully depreciated and the mortgage is paid off.
At which point, an investor can sell the property and “trade” into a another property via a 1031 exchange and start the cycle over again. I know real estate investors that have done this 30+ years without mailing Uncle Sam a check.
3. Real Estate Offers Inflationary Protection:
You might have a large bond / stock portfolio that meets your income needs, but you are likely losing money in real terms thanks to inflation.
This is less of a concern with real estate investments, as the ability to increase rent and pay down fixed interest debt with “cheaper” dollars hedges the investors exposure to inflation.
4. Ability To Influence The Investment Outcome Through Effective Management:
Despite your best efforts, you’re not going to be able to impact the success of your Chipotle stock (no matter how many burritos you put down a year).
5. Direct Real Estate Holdings Typically Offer Higher Cash Flow Yields Than Stocks (Dividends) Or Bonds (Interest Payments):
This obviously depends on buying the right properties in the right markets.
However, all things being equal, the illiquidity premium, management factor and the ability to use substantial leverage with accretive debt all translate to higher returns relative to most retail investors’ stock & bond portfolios.
Additionally, while I certainly don’t believe that the stock / bond market is completely “efficient”, real estate pricing is less transparent and offers savvy investors more information asymmetry advantages than the stock market.
This last point is where real estate truly stands out from a number of other investment options in term of funding one’s retirement.
The ability to generate double digit, after tax cash flow returns enables holders of real estate portfolios (that don’t over-leverage) the ability to live off their cash flow indefinitely.
There are no withdrawal rate calculations to worry about, you’re hedged from inflation, your paying little if anything in taxes, your tenants pay down your mortgage, and you’re slowing accruing appreciation (should you decide to sell instead of gifting your portfolio to your children).
Naturally, individuals who accumulate $20,000,000 in cash, can just put their money in a fixed income investment and live comfortably off the payments without losing principal. However, most of us will need superior returns to retire without worry.
Perhaps the largest downside to using real estate to fund a retirement is the active management component, which may or may not be appealing to you.
Yet, many investors enjoy the semi-retirement, part time work involved with managing a real estate portfolio (assuming one has great team in place).
Purely passive minded investors can remove themselves even further by investing with real estate sponsors who handle the day-to-day management of their direct real estate holdings.
Passive investors can also pay for professional asset management companies to steward their property managers and RE holdings.
I suspect that stocks and bonds will be the dominant retirement investments for centuries to come. Therefore, they should be a component of every diversified investment portfolio.
However, rather than worrying whether your money will last as long as your retirement, you might want to consider amassing a portfolio of appropriately leveraged, cash flowing properties that can generate enough cash flow to fund your retirement indefinitely.
How do you feel about real estate as a retirement vehicle?
Be sure to leave your comments below!