When was the last time you seriously thought about your investment goals and whether or not your current strategy is going to allow you to meet them? If you are like most people, you haven’t spent a lot of time thinking about this. You put money into your 401(k), IRAs, and maybe even save outside of your retirement accounts. You may have an idea of your “number”, based on the 4% or other withdrawal strategy and are fervently working to get to that number so you can be financially free.
But do you know why you are investing in stocks / bonds / whatever vehicle you are? Did you investigate the underlying assumptions that you made about that strategy and see if the approach you are taking is really aligned with your goals?
For over 10 years, when I was trying to establish my career, I didn’t. I was working extra hours trying to build up my career and didn’t spend a lot of time thinking about my retirement plans. I was maxing out my 401(k) (all into index funds) and putting more money into my brokerage account (also index funds) totaling ~20% of my income. For a while, the only rental property I had was a short term rental property that I bought more as a second home than a cash flow machine, so while I could enjoy a couple of weeks a year skiing, it was costing me money every year (note: this is not an approach I recommend :)). I trusted that the money I was putting away in the market would compound at an average of 7% and when I was ready to retire, which I wanted to do well before I hit 65, I would be set for life. I was planning on being able to maintain my current standard of living indefinitely based on hitting my number. That was, after all, what everyone told me was the responsible thing to do. And I didn’t question that assumption.
I thought I was getting closer to my goal. And I was. I had additional, cash flowing rental properties as well as my retirement accounts. But I wasn’t close enough to be able to retire when I wanted to. The money I was putting into my retirement account wasn’t growing as fast as it needed to in order for me to maintain my lifestyle – even if I was able to access it before I turned 59.5.
What was I doing wrong? Why wasn’t I able to retire on schedule and have the lifestyle I had been planning for? I figured out that there were several areas where my goal and my strategy were not aligned.
First, I wanted to have a long and active retirement. I wanted to maintain (or possibly even exceed) my current standard of living. That meant I needed to pull a lot of money out of my retirement accounts and it would be taxed as normal income – which means that I would be paying at least as much in taxes when I retired as I was now. These days, it surprises me when financial planners expect you to be in a lower tax bracket when you retire – if you are getting your money from your 401(k) that means you are not maintaining your lifestyle since that is taxes as normal income (assuming tax rates stay the same and don’t increase). My plan also meant that I couldn’t rely on the 4% rule, which is based on a 30 year retirement, I needed to have even more money than I had thought since I needed to plan for a much longer retirement.
Second, there is an often omitted footnote when talking about the stock market. Everyone can repeat that the average return of the stock market is 10% over the long term (or as low as 7% depending on your assumptions). But that doesn’t mean that you got that annualized rate of return in your investments. That number is the average of the returns of the market over that time. The amount of money you would actually get is less. Consider that if you invested $100 in the market, it went down 10%, then went up 30%, you would end up with $117 ($100 – $10 [10%] = $90 + $27 [30%] = $117). So even though the average return on those two years was 10% (-10% + 30% = 20% / 2 = 10%), your return was about 8% per year, compounded – and that doesn’t count any taxes and fees you would have paid. It is better than nothing, but far from the $121 you would expect from a 10% compounded growth rate( $100 + $10 [10%] = 110 + $11 [10%] = $121). And the impact is greater over time given the nature of compounding. As a result, the returns I was seeing over the long term were significantly less than I expected.
To turn things around, I needed to better align my goals (long, active retirement) with my investment strategy. That is when I moved from focusing on appreciation based investing to cash flow investing [1]. It was also when I started taking real estate investing more seriously. I started actively growing my single family rental portfolio, benefiting from both the cash flow and the tax advantages from those properties. About 5 years ago, after not being able to scale this approach while working full time, I discovered syndications and truly passive investing.
This strategy is much more closely aligned with my goals:
- the focus on cash flow means that I don’t have to worry about running out of money during my retirement since I am never drawing down my principal;
- because the cash flow roughly follows inflation, once I have enough to match my currently lifestyle (which I currently do not, but I am continuing to work at it), I should be able to maintain that indefinitely;
- I can evaluate the different asset classes and opportunities to adjust my investments based on my risk profile;
- the passive cash flow is tax advantaged, so it compounds faster; considering the tax advantages, the actual rate of return I get is higher than I was getting in the stock market.
I still invest in the stock market, but not as aggressively as I have in the past. Most of my discretionary investment money is flowing in to passive real estate investments. And I am moving much faster towards my goal. It isn’t a get-rich-quick approach, since I am conservative in my investments and focusing on cash flow not growth, but it will take much less time to accomplish my goals using this strategy than with the path I started on.
How aligned is your investment goal and strategy? Are you going to get there? Is there a faster way to meet your goal by using a different strategy?
If you have any questions or comment about this post, please email them to me at blog@mbc-rei.com, I will reply to the questions that are straightforward and will turn the questions requiring more detailed answers into future blog posts.
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This article is my opinion only, it is not legal, tax, or financial advice. Always do your own research and due diligence. Always consult your lawyer for legal advice, CPA for tax advice, and financial advisor for financial advice.