How much do you need to retire and how can your Investment Policy Statement help you get there?

When do you think you really need to start thinking about retirement? And what do you make of statements that say you need 2 or 3 million dollars to retire?

When I got my first paycheck as an attending, I thought I would be all set to FIRE (Financially Independent Retire Early) in 2020… Let’s just say I’m not there yet… and that’s not because I have not earned or saved as much as I expected to. It’s because

  • I did not know exactly how much I needed saved up for retirement to be able to live off of it for the next 30-50 years…
  • I did not realize how important it was to identify and be specific about my investment vehicles (ie asset allocation) during my years of saving and later in retirement because their rate of return would determine how fast my nest egg would grow and later how much I could safely withdraw without depleting it …
  • In short, I did not have an Investment Policy Statement (IPS)

As simple as this may seem, knowing exactly what your goals are and having a plan to get there are the first and most important steps in your journey to financial freedom. So I ended up :

  • with a much lower rate of return because of disproportionately large fixed income assets.
  • buying liabilities instead of assets (luxury cars, large personal home etc) per Robert Kiyosaki’s definition where assets put money in your pocket and liabilities take money out of your pocket.
  • and although I was fully contributing to tax advantaged accounts, in some ways I feel I was saving, not investing for retirement.

So how big does your nest egg need to be for retirement?? 1 million dollars? 2.5 million dollars?

It depends… (no cliched answers here, just mathematical ones…)

  1. First calculate how much you need annually during retirement : Make sure you include your home mortgage (unless you will have paid it down in full by retirement), property taxes, cost of health care in retirement, home and car insurance costs, cost of utilities, credit card bills and everyday expenses, transportation costs (leasing or owning a car), vacations etc… Remember to factor in pension and Social security income;
    • Annual need in retirement – (Social Security and pension) = Annual withdrawal from nest egg.
  2. Then decide which investment vehicles you will have in your nest egg… because the rate of return of your investments will determine how much you can withdraw safely every year without depleting your retirement egg. Factor in about 3% inflation rate for Stock/Fixed income assets, Income from rental real estate is inflation controlled.
  3. And finally have a goal for When you intend to retire. The earlier you seek financial freedom, the larger your contributions (accelerated acquisitions in case of real estate investments) to your nest egg will need to be every year. I am including a calculator that helps you calculate how much you need to save each month to hit your retirement goals here.. and your asset allocation and/or withdrawal rate will need minor modifications for stock/bond portfolios if u plan on retiring early.

Most people have a pure Stock/Bond portfolio that they hope to fund retirement with and there are numerous studies and recommendations for what your asset allocation should be for optimal rate of return and what withdrawal rates need to be to draw down your assets and have it last 30 years or more (it is very hard to live off the income from a Stock/Bond portfolio unless the portfolio is immensely large).

Some people use only Real estate investments to fund retirement, and the best part is – you can live off the income/ cash flow… and pass your assets down to your kids with a stepped up basis !! Win-win.

I use a hybrid Stock/ Bond/ Real estate portfolio which I will also discuss briefly. I want to point out that I will not be including commodities, cryptocurrency in this discussion as I feel for most people they don’t have a place in retirement planning and draw down strategies.

Pure Stock/Bond portfolio:

$ needed annually in retirement x 25 = Retirement Nest egg

For a pure Stock/ Bond portfolio to last you at least 30 years

So suppose you need your Stock / Bond portfolio to provide you with 60k annually in retirement, your nest egg should be 1.5 million dollars (60,000 x 25) and so on.

These numbers will work if :

  • Weighting of Stock:bond portfolio at retirement is between 50:50 and 60:40. With historical Stock returns being around 10% and Bonds yielding around 5%, this portfolio should yield anywhere from 7.5% to 8%; factoring in 3% for inflation, that leaves you with a Safe annual withdrawal rate of around 4% to have the portfolio last at least 30 years (average rate of return – inflation) as shown by Bengen in 1994 (he revised safe withdrawal rate to 5% in 2020). [ 0.04 (withdrawal rate) x 1,500,000$ (nest egg) = 60,000$ (annual withdrawal)]
  • Your Stock/ Bond portfolio investment returns match historical returns. I believe that the best retirement stock portfolios are predominantly composed of passive index funds (and not individual stocks) such as those offered by Vanguard (preferred for their passive management, low costs, wide diversification and tax efficiency).
    1. A popular strategy for Stock/Bond asset allocation is the 3-fund portfolio, which includes in varying proportions (based on your need for diversification, risk appetite and time to retirement) of
      • Total US Stock Market Index Fund (VTSAX)
      • Total International Stock Market Index Fund (VTIAX)
      • Total US Bond Market Fund(VBTLX)
    2. Or if you are like me and prefer lesser portfolio volatility to small cap and international exposure, you can stick to a 2 Fund portfolio comprised of VFIAX (S&P 500 Index fund) and VBTLX (Total US Bond Market Fund).

If you plan on retiring early, your portfolio needs to last longer which can be achieved by increasing your stock:bond allocation to 70:30 (these portfolios will however decline more sharply during big bear markets) or by decreasing the withdrawal rate to 3% (which is the safer option hopefully causing your portfolio to last 50 years or longer).

Stick to your plan for asset allocation through market ups and downs by periodically re balancing your portfolio. Over long periods the market will go up despite short term volatility and the withdrawal rate calculations only work if you stick to the plan at all times.

Pure Real estate portfolio: Real estate Investing can be passive (REITs, syndication) or active (Joint Ventures or direct ownership). I prefer direct ownership for more control over the asset and higher rewards due to increased tax benefits. I discussed FIRE with real estate in a previous post including how your rental real estate returns are actually much higher than just Cash on Cash (CoC) returns, but lets move ahead with the conservative approach of only including CoC returns in our calculations.

$ needed annually in retirement x 10 = Amount invested in rental real estate at time of retirement

For a pure Real estate portfolio (leveraged) to last you for ever

So suppose you need your Real estate portfolio to provide you will 60k annually in retirement, then you can reach this goal with around 600k of leveraged investments (60,000$ x 10= 600,000$) and so on. You could also calculate your annual cash flow from each door and see how many doors you need to own before you hit your and cash flow numbers for retirement.

These numbers will work if:

  • you have 10% Cash on Cash CoC return from your real estate investments (post tax return for passive real estate investments).
  • your investments are leveraged, meaning you have a mortgage on the property, which increases your rate of return. For example, if you buy one house for 200,000$ down and generate cash flow of 1000$ per month, your Cash on Cash return is 6%. But if you use the same 200,000$ and split it into 25% down payments for 4 homes each 200,000$ with mortgages on them and each generates 500$ in cash flow, your monthly cash flow is 2000$ or 12% CoC return.

Don’t forget the additional perks of real estate investing –

  1. Annual cash flow is tax free for most direct ownership in rental real estate due to depreciation.
  2. As your property appreciates in value and your renter pays down debt, your equity in the property is increases; you can tap into this equity by doing a cash out refinance without having to sell the property.
  3. Rent is inflation controlled
  4. In this scenario, unlike with a stock:bond portfolio, you are not drawing down assets – you are actually living off the income.

Hybrid Stock:Bond:Real estate portfolio: Some of you, like me, likely fall in this category and would rather not put all our eggs in one basket.

In our case, as we are targeting 60-100k annual withdrawal in retirement, our goal for retirement is :

  1. 750k in stocks/bonds giving us a safe withdrawal of around 25-30k (lower withdrawal rate of 3% if we retire early)
  2. 500k in leveraged real estate investments (direct ownership) that if invested well should yield 50k in tax free cash flow annually

You will notice that adding real estate into the picture will propel you towards your retirement goals much faster. But again, it is very important to be specific about how many doors/ units you will need and your markets (I prefer cash flowing markets over markets that see higher property appreciation).

My Goal Hybrid Asset Allocation in retirement

And that’s the end of a long post… Hopefully you already have a written Investment Policy Statement IPS that clearly states when you want to retire, how much you will need to retire and how you will be invested going forward to get to those goals . If not, there is no better time than now to get started!

First things first… Your ROADMAP to financial health

The right path…

As you have probably realized, growing wealth is not just about investing. If you are striving to increase your net worth, it is imperative to have certain protective systems in place prior to embarking on your investing journey and to take advantage of key strategies that help compound your investment growth. The earlier you arm yourself with this knowledge, the better and I wish I knew 10 years ago what I know now, but it is never too late to check your progress and realign yourself. This is a bird’s – eye view of what should be included in your financial blueprint…

PROTECTOPTIMIZE INVEST
financial planning

PROTECT your INCOME & ASSETS:

  • A big part of protecting your nest egg is INSURANCE. Apart from the mandatory Home/ Auto and Malpractice insurance, in my opinion there are 3 other insurances that you should consider padding yourself with in the below order:
    1. Long Term Disability Insurance: Most physicians who don’t have children prior to completing fellowship will probably end up getting a personal Long Term Disability Insurance plan prior to starting their first job as premiums are lower when you are younger and in a lower income bracket. Without going into much detail, it’s good form to get an OWN OCCUPATION policy and pay attention to contractual language with reference to Return to work, Residual disability, Cost of Living Adjustments riders. More on this later.
    2. Life Insurance: Most people start thinking of Life insurance once kids are in the picture and it is always smart to have your own Life insurance policy that you will carry with you even if you change employers, again the earlier the better as premiums begin to increase with age. With a myriad of options out there – Whole life, Term Life with ROP (Return of Premium), Term life without ROP – it can get very confusing very fast. In my opinion you are best served getting a Term Life Insurance policy for 20 – 30 years (depending on how young your children are), a tiered plan is a great strategy and invest the savings in annual premiums. More on this later…
    3. Umbrella Insurance: Considering the relatively low cost of an umbrella insurance policy, it’s always a good idea to carry some coverage, more so if you have multiple rental properties that are in your personal name.
  • LAST WILL AND TESTAMENT, TRUST AND LIVING WILL: Once you have assets, it is never too early to create a Last Will and Testament, but it is important to remember that having a Will still does not prevent your Estate from going to probate, a time and money consuming process that you do not want to put your loved ones through, which is why you ideally want a Revocable or Living Trust with a Pour over Will to capture assets that have not been transferred to the Trust. It is also best practice to have Beneficiaries (POD or payable on Death) named on your bank and retirement accounts. A Living Will is a legal document outlining your end of life medical treatment choices.

OPTIMIZATION:

  • Tax efficient investments: It is prudent to fund your tax deferred investments before funding your investments with post tax dollars. During residency, one of the most important things you can do to speed toward your financial goals is to contribute to Roth IRAs (contributions made with post tax dollars for tax free growth) for yourself and your spouse and a 401(k) plan if offered by your employer (bonus points if there is an employer match). After training, it is best practice to max out 401(k) or 403(b) plans offered by employers that are tax deferred (Solo 401(k) or SEP IRA if you are self employed – most often a Solo 401(k) is a better option if you do not have additional employees beyond your spouse), following which you should contribute to Backdoor Roth IRAs (a way for high-income earners to fund a Roth) for both yourself and your spouse. If you have access to a Health Savings Account (HSA) this is an additional way to invest tax deferred money that can be withdrawn after age 65 to pay for any expense without penalty.
  • DECREASE LIABILITIES AND SPENDING: Remember ” a dollar saved is more than a dollar earned…” because of the taxes we pay on earned income. Reading RICH DAD POOR DAD was eye opening because a new home or fancy car are actually Liabilities since they take money out of your pocket and the best way to build wealth is to save and buy Assets that put money into our pocket.
  • DEBT: Paying down debt and/or refinancing to a lower interest rate on credit card/ Home mortgage and student loans is something you should have on your radar.

INVEST AND GROW: I will be listing the most common investment vehicles here and discussing them in future posts. With investing it is key to have a written IPS- INVESTMENT POLICY STATEMENT based on your goals, priorities and risk appetite. Your IPS will serve as a roadmap and help you re balance your portfolio allocation periodically to stay aligned with your goals and not get swayed by market ups and downs.

  • Stocks and Bonds: Please refer to my post on creating your Investment Policy Statement for recommended asset allocations; allocation will depend on your risk appetite, investment goals and timeline. I want to stress that low cost INDEX INVESTING is my preferred recommendation for a passive investor as opposed to individual stocks.
  • Commodities
  • Real Estate: My go-to for building generational wealth… I prefer direct ownership over passive real estate investing as it gives you more control and tax savings, but it does require more active participation. Check out this post…
  • Cryptocurrency: with it’s performance in 2020, it has definitely earned a mention, although I consider this risky.
  • Savings account and CDs: With current interest rates, hoarding money in your savings account will likely not even beat inflation, thereby devaluing your money over time. Therefore once you have a comfortable buffer, usually 6 months worth of expenses (your emergency fund), it makes sense to invest your money in other baskets.
  • Saving for kids: Most people contribute to a 529 College savings plan which in some states is tax deductible and front loading this contribution helps compound growth significantly. If you have a small business then a more tax effective strategy would be income shifting by employing your children through the business, and contributing to a Roth IRA in your child’s name – contributions can be pulled out to pay for college, earnings may be used for qualified education expenses without a penalty.

As I mentioned before, the first step is to sit down with your significant other, ensure your protection strategies are in place and write down your Investor Policy Statement IPS, because as simple as this may seem, knowing what your goals are and having a defined strategy are the most important steps in your journey.

A journey of a thousand miles begins with a single step…

WHY and WHEN to rehab your rental?

Many new investors in the Single Family Home space prefer acquiring turn key rentals- homes that don’t require any major work prior to renting; this is a safe and foolproof acquisition strategy for steady cash flow. Today I wanted to focus on why purchasing a property that requires some TLC actually makes more financial sense and significantly increases your cash flow.

Before we start though, we need to absolutely clear that this strategy only works if you are able to find a property that needs some work at a significant discount. In the COVID market these deals are hard to come by as property appreciation is seen across the board due to decreased supply. Properties that need significant work put in with a similar discount to the pre- Covid market are hard to come by. But if you can find a good cash flowing property that is discounted as it requires some upgrades, then this is definitely a strategy to consider.

The right time to do a rehab on your rental is right after acquisition, before you put your rental in service. When you do this, you are increasing the value of your property – FORCED APPRECIATION by increasing it’s ARV (After repair value). A lot of savvy investors will tap into this increased equity right away by doing a cash out refinance. Also, with your newly renovated property, hopefully you have increased your monthly rental cash flow; win-win. Let’s dive into an example to look at the numbers…

Scenario: Say you purchased a Single Family rental property for 250,000$ and put 20,000$ into renovations. If the ARV of your property increases to 300,000$ then you have forced appreciation of the property by 30,000$ (300k – 270k)! Now you may choose to leave the increased equity in the property in favor of increased cash flow or if you are in the growth phase, you could tap into the increase in equity with a cash out refinance. Hopefully with the upgrades you can also increase monthly rent from 2500$ to 3000$ which increases your cash flow by 6000$ annually. Now depending on your tax situation ( AGI, Real estate Professional Status and material participation in the property concerned) or if you choose to do a cost segregation study on the property in the year of acquisition you may be eligible for tax breaks that further offset your out of pocket cost of the rehab by up to 20 – 30%.

Pictures from a recent rehab on one of my rentals,,,

Budget: Once you’ve made the decision to rehab your rental, the first order of business is to determine what your budget is going to be. It’s very important to be realistic here so you are clear on what you want to upgrade from the very beginning. It’s very disruptive to the timeline and expensive to have to modify plans later if you decide to bump your budget up and add things. For rentals, IMHO the most bang for your buck is in renovating kitchens and bathrooms and converting at the very least common areas from carpet to hard surfaces so you don’t have to periodically replace the carpet if pets and kids have trashed it. Most of the time, cosmetic changes give you the most bang for your buck and moving plumbing lines or electrical fittings or tearing down walls can be expensive without a proportionate yield. I have also found that in a mid size renovation (if you are spending over 10-15k), especially if structural changes are being contemplated, it makes sense to include an architect in the initial planning. They usually get paid by the hour and their opinion and expertise could save you a bunch of money overall or at the very least ensure that your money is spent in the most high yield items in pursuit of durable and contemporary materials. You do not want to tear down walls only to later realize that there was a more cost effective solution to provide you with a better result in terms of flow in the space. Or to replace your countertops to later realize that you should have upgraded to larger appliances as they are the norm in your market. Oftentimes having someone experienced look over the renovation plans (especially if you are essentially functioning as your own general contractor) saves you money and frustration in the long run by guiding your choice of materials, appliances and helping you figure out the most cost effective way of getting to your desired outcome.

Sourcing your Materials: As the adage goes ” Kitchens sell homes”. Upgrading appliances makes your rental more attractive for sure, but other things to consider are upgrading tile countertops to single slab countertops and maybe a complimentary backsplash etc. A natural stone countertop like granite is durable, renter proof and these days very cost effective especially if you go the per-fabricated route. That being said, more and more rentals including commercial spaces are getting quartz countertops. Lately, LVP (Luxury Vinyl Plank) flooring has been taking over the lower to mid home markets – it is durable, water proof (which also means kid and pet proof) and you could run it into the kitchen and baths at or below 4$/sqft including installation. That being said, tile flooring is another hard surface flooring that while being slightly more expensive installed, increases the value of your home a tad bit more. And last but not least, a coat of paint does wonders in transforming a room. Sourcing materials for your rehab can be challenging the first time around, but once you have done the research, visited the big box stores like Lowe’s, Home Depot, Costco and all your local showrooms for flooring, appliances, hardware, lighting etc you are now armed with this invaluable knowledge base for your next project. The learning curve is frustrating but steep and if you stick with it, it is very, very rewarding. If you plan on renovating multiple rentals, it helps to use the same materials for flooring, same paint colors etc in all your rentals, this ends up being time and cost effective and if a plank of flooring need to be replaced or paint touched up, you have it handy. Find the formula that works for you, then rinse and repeat. I do want to point out here that it helps to start with a design concept and stick to it so your end result is cohesive in terms of style, scale and color – all of which enhance the vibe and overall elegance of your space.

Building your Team: If you are using a general contractor (GC) for your project, then this part is much simpler. You get a few good references and go from there. It is much harder if you are your own GC for cost considerations or if you are trying to materially participate in the renovation to qualify for Real Estate Professional Status. You will need to have a reliable flooring installer, electrician, plumber, painter, cabinet and countertop guys and handyman for drywall repairs etc. Building this team can seem like a colossal task, but doing the legwork, getting the quotes and finally assembling your team is very gratifying. In my experience, the more experienced licensed professionals were well worth the up charge in the quality of work and insight they brought to the job and I would recommend keeping that in mind while comparing quotes. The most frustrating part of working with your team is unforeseen delays in the time line as this pushes out the other members in the team due to the sequential nature of most rehabs. Changing your mindset to expect these delays shifts your energy and helps a ton.

If you have been acquiring turn key rentals, I hope I have inspired you to try rehabbing your next rental. Don’t let inertia hold you back. It will seem hard many times along the way, but if you stick with the plan and push through, you end up learning so much that you will carry with you into the rest of your real estate journey. Look before you leap, but I assure you, if you take the leap of faith, you will be rewarded ….