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The 10 year Plan
Old 04-08-2012, 11:04 AM   #1
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The 10 year Plan

Second Post, great site here. I have reached sort of a milestone in my life. We paid off our house last month and are debt free. I am 47 and am looking at whats next and have some questions. A little bit about my situation, Im married with two kids 18 and 25, Household income is pretty high, a bit over 200k but we live in a high tax state (Illinois) . My wife works but only accounts for about 50k of that income. My job is not secure and never will be, the mega corp I work for has a nasty habit of layoffs, good times or bad.

I have two things that I am trying to achieve, 1) Retire Early, like 10 years from now 2) protect myself from mega corps random layoffs. I would not likely remain unemployed for very long, but i very much doubt I would ever see income like this again. So I view this as a race between me and my employer

My Current situation is about 350k in 401k assests between my wife and I, and putting in max every year. Both have 5% match. Neither of us has any pension nor will we ever, so its all on us. During the real estate bust, I was able to acquire 1/2 interest in 4 homes at fire sale prices, all are cash flow positive and yied me about $700 month in income. I have pretty much been a passive investor without much of a plan except to save as much as reasonably possible. I viewed the real estate meltdown as a once in a lifetime opportunity to buy into what i view as an inflation protected annunity very cheap. The houses provide some passive income now hence helping me to start offsetting my layoff risks.

Due to paying off my house, I have very little money at the moment but I have a very high cash flow, on the order of $4k/mo and I am now planning on a sprint for 10 years saving about that much. So i veiw my next steps as almost entirely in taxable accounts. I have looked at some model portfolios and have modified them to remove REITS and Bonds, but are still very highly diversified across the equity space.

Ok, if you have gotten though this wall of text, here are some questions and thoughts for comment.

Question 1. Is buy and hold still reasonable, especially if you invest in ETFs with reasonable dividend yields. The reason I ask this is that I think i will be only pouring money into this basket, not rebalacing since i want to minimize the taxable events. If i rebalace via contribuionis, can buy and hold work?

Question 2: I view my paid off home as a bond and given current interest rates, feel buying bonds now would end badly. Is this a reasonable view?

Question 3: Since my current asset allocation is very heavly slanted into physical real estate, does my thinking to avoid REITS make sense?

Final Question: You may have noticed that I do not have any IRA's, roth or conventional. At my income level, i can not invest in a roth ira, but could start putting money into a roth 401k at work if i chose to. I am hesitent to tie up cash in a regular IRA considering my Employment risk. But im really torn on this. Any thoughts would be welcome.

Thanks in advance all.

Steel
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Old 04-08-2012, 11:40 AM   #2
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SR,

Congrats on being debt free! My 2 cents:
Not having much tax sheltered, other than the $350K, is an area you may want to focus on. Also, what type of investments are in the 401K, are they low cost funds?

Q1:Can you not contribute into a non-deductible IRA? If so, you can convert to a Roth every year (google 'back-door Roth). Taxable accounts are not the way to go long term, IMO. Likewise EFT's are not necessary as you can go with a low cost Vanguard fund. There are many reasons to be wary of EFT's, too complex to discuss here.

Q2: Bond Funds, in a tax sheltered account, are a good part of a balanced
portfolio.

Q3: REITs are OK, after you have a diversified tax sheltered portfolio. However not a major part of your mix. I think a 401k Roth is not as good as a regular Roth, as I believe the former has a mandatory distribution requirement that a regular Roth does not. It would be best to max the 401K (assuming it is not in company stock or other high fee investment) and use the back door roth method to fund a regular Roth each year.

SM
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Old 04-08-2012, 11:47 AM   #3
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Congrats on being debt free! We paid off our home and all else about 4 years ago and it feels wonderful. Although we have nowhere near the income you have, it still has helped us to add much more into our savings, 403b's etc.
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Old 04-08-2012, 11:52 AM   #4
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I'm nominally 100% equities and basically buy and hold, so yes from me for questions 1 & 2. Particularly since you are effectively DCAing into the market.

I like to hold REITs as something that can gain as much as other equities but can move differently (or even just more). A REIT fund would probably not follow your property values or income all that closely. And you may not be rebalancing your properties versus the rest of your portfolio. So I vote for REITs in question 3.

You should do a "backdoor" Roth IRA contribution, as it sounds like you don't have any other IRA's. That gets you $10k of otherwise taxable money into a Roth. You do it by opening normal IRAs for both you and DW, make a non-deductible contribution of $5k to both, and then converting both into Roth IRAs. There is no significant tax consequences since only the earnings in the IRA will be taxable when you convert. There is a big discussion now on waiting periods between contribution and conversion, so you might read up and decide what you're comfortable with.

Other than the backdoor contributions, wait on the Roth 401k or other contributions. You should have significant after-tax savings at the rate you are going. When you retire early, live off your taxable accounts and convert 401k/IRA Rollover to Roth 401k/IRA to the extent that it brings you up to the 15% or so tax bracket each year. Your average tax will be even less than 15%. That's much better than paying 25% now. However, you'll need to run the numbers to make sure your taxable funds will last until you can withdraw from your 401k/IRA accounts at 59 1/2.
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Old 04-08-2012, 11:54 AM   #5
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SR,

Congrats on being debt free! My 2 cents:
Not having much tax sheltered, other than the $350K, is an area you may want to focus on. Also, what type of investments are in the 401K, are they low cost funds?

Q1:Can you not contribute into a non-deductible IRA? If so, you can convert to a Roth every year (google 'back-door Roth). Taxable accounts are not the way to go long term, IMO. Likewise EFT's are not necessary as you can go with a low cost Vanguard fund. There are many reasons to be wary of EFT's, too complex to discuss here.

Q2: Bond Funds, in a tax sheltered account, are a good part of a balanced
portfolio.

Q3: REITs are OK, after you have a diversified tax sheltered portfolio. However not a major part of your mix. I think a 401k Roth is not as good as a regular Roth, as I believe the former has a mandatory distribution requirement that a regular Roth does not. It would be best to max the 401K (assuming it is not in company stock or other high fee investment) and use the back door roth method to fund a regular Roth each year.

SM

Thanks for the feedback. Answers to answers... The 401Ks are all equities in low cost funds, all under .3% except for one of the emerging market funds which is lilke .55%. I am very afraid of bonds at the moment, but am willing to reconsider, which is why i asked. I did look at a corporate bond fund, it would be in the 401. So, viewing my house as a bond like invstement is not really accurate then?

I think everyone can do regular IRAs, and I have heard of the back door one, but dont know much about it, will have to hit google on that. As far as ETFs go, the only worry that i know about them is certain liquidity issues with new or small ones. If you could point me somewhere that could summerize this, i would be grateful. I see ETFs as cheap mutual funds

Kevin;
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Old 04-08-2012, 12:00 PM   #6
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I'm nominally 100% equities and basically buy and hold, so yes from me for questions 1 & 2. Particularly since you are effectively DCAing into the market.

I like to hold REITs as something that can gain as much as other equities but can move differently (or even just more). A REIT fund would probably not follow your property values or income all that closely. And you may not be rebalancing your properties versus the rest of your portfolio. So I vote for REITs in question 3.

You should do a "backdoor" Roth IRA contribution, as it sounds like you don't have any other IRA's. That gets you $10k of otherwise taxable money into a Roth. You do it by opening normal IRAs for both you and DW, make a non-deductible contribution of $5k to both, and then converting both into Roth IRAs. There is no significant tax consequences since only the earnings in the IRA will be taxable when you convert. There is a big discussion now on waiting periods between contribution and conversion, so you might read up and decide what you're comfortable with.

Other than the backdoor contributions, wait on the Roth 401k or other contributions. You should have significant after-tax savings at the rate you are going. When you retire early, live off your taxable accounts and convert 401k/IRA Rollover to Roth 401k/IRA to the extent that it brings you up to the 15% or so tax bracket each year. Your average tax will be even less than 15%. That's much better than paying 25% now. However, you'll need to run the numbers to make sure your taxable funds will last until you can withdraw from your 401k/IRA accounts at 59 1/2.
Thanks very much for the feedback. I had not considered that REITS will not nessasarly move in concert with my Rentals, that is a very good point. One other thing i considered, is an international REIT or maybe one that is focused on commercial property.

Steel
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Old 04-08-2012, 12:01 PM   #7
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From what you have outlined, given your high level of income, it would seem likely that when you retire that you will be in a lower tax bracket than while working, so I would think it would be best to max out any tax-deferred opportunities available to you. You are currently maxing out the 401ks, which is good.

Do either of your employers offer HSAs? One strategy that I used was to max out contributions to my HSA but pay my health care costs (deductibles, etc.) from cash flow and let the HSA sit there and grow. In a sense, it is similar to making contributions to a Roth IRA without the income limitations but with a constraint on withdrawals (that they be for health care costs otherwise they are taxable).

On your questions, I think buy and hold is still perfectly reasonable and it is possible to rebalance using new money. I would not think of my home as a bond, it is a place where I live that has a savings element to it. I don't count my home in any of my retirement planning - at the very end it will either go to the kids or if my projections are really bad, it will be sold and used to fund our real later years. If you plan to downsize when you retire then it might be reasonable to view the difference as a potential cash flow.

Given your investment properties, I would agree that avoiding REITs makes sense. However, some might argue that your investment properties are geographically and property type concentrated and some REIT would provide diversification.

Once you max out 401ks, HSAs, Roths, etc. then the only real alternative is taxable accounts. I'm more of a fan of taxable accounts than non-deductible IRAs, particularly in your case given your job situation. If you were to get laid off, your could tap any taxable investments if needed and if you don't you can use them for living expenses from 57 until you draw SS and you'll have very little taxable income and can convert 401k>tIRA>Roth at a low tax cost.
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Old 04-08-2012, 12:07 PM   #8
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....You should do a "backdoor" Roth IRA contribution, as it sounds like you don't have any other IRA's. That gets you $10k of otherwise taxable money into a Roth. You do it by opening normal IRAs for both you and DW, make a non-deductible contribution of $5k to both, and then converting both into Roth IRAs. There is no significant tax consequences since only the earnings in the IRA will be taxable when you convert. There is a big discussion now on waiting periods between contribution and conversion, so you might read up and decide what you're comfortable with.

.....When you retire early, live off your taxable accounts and convert 401k/IRA Rollover to Roth 401k/IRA to the extent that it brings you up to the 15% or so tax bracket each year. Your average tax will be even less than 15%. That's much better than paying 25% now. However, you'll need to run the numbers to make sure your taxable funds will last until you can withdraw from your 401k/IRA accounts at 59 1/2.
+1 on back-door Roth and Roth conversions while ER'd. I project that if I fill the 15% bracket my tax on the conversions will be ~10%.

Another thing to check out is whether your 401ks allow you or DW to draw on them without penalty if you leave after you are age 55 (some plans do). If so, and if your taxable investments aren't able to carry you from ER to 59 1/2, then those could be your source of withdrawals once your taxable investments are exhausted.
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Old 04-08-2012, 12:16 PM   #9
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From what you have outlined, given your high level of income, it would seem likely that when you retire that you will be in a lower tax bracket than while working, so I would think it would be best to max out any tax-deferred opportunities available to you. You are currently maxing out the 401ks, which is good.

Do either of your employers offer HSAs? One strategy that I used was to max out contributions to my HSA but pay my health care costs (deductibles, etc.) from cash flow and let the HSA sit there and grow. In a sense, it is similar to making contributions to a Roth IRA without the income limitations but with a constraint on withdrawals (that they be for health care costs otherwise they are taxable).

On your questions, I think buy and hold is still perfectly reasonable and it is possible to rebalance using new money. I would not think of my home as a bond, it is a place where I live that has a savings element to it. I don't count my home in any of my retirement planning - at the very end it will either go to the kids or if my projections are really bad, it will be sold and used to fund our real later years. If you plan to downsize when you retire then it might be reasonable to view the difference as a potential cash flow.

Given your investment properties, I would agree that avoiding REITs makes sense. However, some might argue that your investment properties are geographically and property type concentrated and some REIT would provide diversification.

Once you max out 401ks, HSAs, Roths, etc. then the only real alternative is taxable accounts. I'm more of a fan of taxable accounts than non-deductible IRAs, particularly in your case given your job situation. If you were to get laid off, your could tap any taxable investments if needed and if you don't you can use them for living expenses from 57 until you draw SS and you'll have very little taxable income and can convert 401k>tIRA>Roth at a low tax cost.
All I can say is wow, I had never thought of using and HSA as a savings vehicle, thats very out of the box, I love it. I am so glad I signed up here, I will have to check an see if either employer offers something like ths. Very cool idea.

Steel
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Old 04-08-2012, 12:20 PM   #10
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All I can say is wow, I had never thought of using and HSA as a savings vehicle, thats very out of the box, I love it. I am so glad I signed up here, I will have to check an see if either employer offers something like ths. Very cool idea.

Steel
Glad you like it. I wish I could claim the idea, but my ex-employer actually advocated it as a potential strategy when they introduced the HSA for employees. I had the same reaction as you when I first heard of it.
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Old 04-08-2012, 12:25 PM   #11
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Question 1. Is buy and hold still reasonable, especially if you invest in ETFs with reasonable dividend yields. The reason I ask this is that I think i will be only pouring money into this basket, not rebalacing since i want to minimize the taxable events. If i rebalace via contribuionis, can buy and hold work?
You still need to rebalance and tax-loss harvest. You can do the rebalancing in your 401(k) and tax-advantaged accounts. As you build up in taxable with tax-efficient investments, you will need to in tax-advantaged to move from equities to bonds. Consider your portfolio of all accounts as a single portfolio. Once again, do not forget to sell losing positions in tax-loss harvesting moves.

Question 2: I view my paid off home as a bond and given current interest rates, feel buying bonds now would end badly. Is this a reasonable view?
No. Your home is not an investment.

Question 3: Since my current asset allocation is very heavly slanted into physical real estate, does my thinking to avoid REITS make sense?
I have no opinion on this. Many folks just use the REITs found in total market index funds and do not buy a separate REIT fund anyways.

Final Question: You may have noticed that I do not have any IRA's, roth or conventional. At my income level, i can not invest in a roth ira, but could start putting money into a roth 401k at work if i chose to. I am hesitent to tie up cash in a regular IRA considering my Employment risk. But im really torn on this. Any thoughts would be welcome.
You need to learn about back-door Roth. You can do this for 2011 right now and probably for 2012. For you and your spouse.

You may also wish to consider I-bonds as another tax-advantaged vehicle.


Thanks in advance all.

Steel
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Old 04-08-2012, 12:34 PM   #12
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20/20 Hindsight?
-I wish I had bought More Rental Townhomes than I did
-I focused on paying them off in the 15 yr Window 1st and No profits on them, until then
-Investing into Wall Street? Not a Good Idea
The best Investments we did was into Just Balanced Funds, starting with VWELX and after Getting $50k in that, added another till we had 6 of them..
-BF's are like Hiring FA's all specialist.. and have done ok..
But the Real Estate is by far the better way to go for us..

Of course, IAD on What Kind of Properties and Where..
Ours in the North Suburbs of Chicago> North Shore.. Prime Area..
and renting to the right kinds of people..
If you can do that ? Own More RE..
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Old 04-08-2012, 01:08 PM   #13
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20/20 Hindsight?
-I wish I had bought More Rental Townhomes than I did
-I focused on paying them off in the 15 yr Window 1st and No profits on them, until then
-Investing into Wall Street? Not a Good Idea
The best Investments we did was into Just Balanced Funds, starting with VWELX and after Getting $50k in that, added another till we had 6 of them..
-BF's are like Hiring FA's all specialist.. and have done ok..
But the Real Estate is by far the better way to go for us..

Of course, IAD on What Kind of Properties and Where..
Ours in the North Suburbs of Chicago> North Shore.. Prime Area..
and renting to the right kinds of people..
If you can do that ? Own More RE..
All 4 of our rentals are in Montgomery, all withing a few blocks of each other. Its all post war housing, 3 beds 1 or 1 1/2 bath, Oswego 308 schools, so what would be called bread an butters. They have been giving these things away, what we have been doing is buying them at 60ish k each, putting about 10k in, then renting them for about 1400. Seems that with the meltdown, there are tons of renters, so we have been 100 percent occupied for several years. We buy them in cash, then do the work, wait one year and get a fannie may mortgage out for 75% LTV. The net result is we actually put cash in our pocket and still drive 400 mo cash flow. I will take all i can get, but it seems that there are less of them around at the moment. Could be because of the foreclosure slowdown due to robo signing, but we keep looking and can move if we see what we want.

Steel
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Old 04-10-2012, 03:04 PM   #14
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Question 2: I view my paid off home as a bond and given current interest rates, feel buying bonds now would end badly. Is this a reasonable view?
No, I do not view the paid off house as a bond. Your house is a shelter. You may count it as part of your net worth, but unlike a bond, it does not generate income for you (unless you rent it out). I view housing as a necessary expenditure.
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Old 04-10-2012, 03:32 PM   #15
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FWIW, alot like earlier replies...
Quote:
Originally Posted by Steel Rain View Post
I have two things that I am trying to achieve, 1) Retire Early, like 10 years from now FIRECalc: A different kind of retirement calculator is good way to find out if you're on track for 10 years out.

Question 1. Is buy and hold still reasonable, especially if you invest in ETFs with reasonable dividend yields. The reason I ask this is that I think i will be only pouring money into this basket, not rebalacing since i want to minimize the taxable events. If i rebalace via contribuionis, can buy and hold work? Buy and hold is always a good option. I almost never "rebalanced" when I was working (to avoid taxes like you), I just changed where my new contributions went to restore my asset allocation. IOW, if my fixed income allocation got light, all new contributions went there until AA was back in line. And vice versa - easy peasy.

Question 2: I view my paid off home as a bond and given current interest rates, feel buying bonds now would end badly. Is this a reasonable view? There are way more real estate knowledgeable members here, but FWIW. Your primary home is not part of your portfolio period. Other real estate is another asset class to itself (if at all), the risk and returns of real estate are unique and unlike equities, bonds or cash (the classic asset classes). Some would call real estate an income source, not part of your portolio.

Question 3: Since my current asset allocation is very heavly slanted into physical real estate, does my thinking to avoid REITS make sense? Not knowing how much of your net worth is in real estate I can't answer. I think most REITs are commercial real estate which would make them a little different than your residential holdings?

Final Question: You may have noticed that I do not have any IRA's, roth or conventional. At my income level, i can not invest in a roth ira, but could start putting money into a roth 401k at work if i chose to. I am hesitent to tie up cash in a regular IRA considering my Employment risk. But im really torn on this. Any thoughts would be welcome. I don't follow this at all, what's the problem with contributing to a 401k at work? Most of us consider the 401k with matching to be the first place to park investments.
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Old 04-10-2012, 09:55 PM   #16
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I tend to agree with pb4uski's comments. The only thing I haven't seen mentioned is an emergency fund. Even with the rental income, I would want to have ~6 months of expenses in readily accessible funds. That also gives you a cushion in case one of the rental properties needs some major repairs the month after Megacorp says "b-bye".

Also, don't be afraid of taxable investments. The way I look at it - I would rather make a gain and pay 1/3 of it in taxes than squirrel the money away and have nothing to be taxed. That said, it's reasonable to look for investments that minimize the taxes. We've invested in Vanguard's Tax-Managed funds for that purpose and they seem to do a good job at minimizing distributions with decent performance.

Congratulations on being debt free!
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Old 04-13-2012, 06:10 AM   #17
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E-Fund is pretty low at the moment, but should be back to snuff by end of the summer. The risk is pretty low that this would be a problem, even in the event of me losing my job. I prepare what I call a zero line budget every year that tells me the bare miniumum monthly expenses to live on and my wifes income covers that amount. Since we just paid off the house, monthy cash flow is very large so rebuilding the efund is happening very fast.

One of the reasons I plan to be focusing on taxable investments so much over the next few years is that I view them as a super E-fund. In the event of me losing my job, I would have a lot of cash to start a business or god willing, FIRE.

Steel
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Old 04-13-2012, 06:19 AM   #18
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FWIW, alot like earlier replies...

About the 401k. Both my wife and I max them, my comment was regarding the option I have to do a Roth 401k. The hitch with this is that the total 401k contribuiton remains the same, but I can allocate any or all of my contributions to a Roth version of this. In my tax bracket, I think that would hurt. I have now essentially concluded that I really need to do yearly backdoor Roth's. I will not be able to do it this year, but I will certainly do it next year.

On the Real Estate question, I would say that it represents over 50% of my net worth, that would include my personal home. In the current situation, all the rentals are hugley cash flow positive and due to the way we buy them, have zero cash in. This is like free money in my mind (not counting the time to manage all this) so its possible that over the next few years, I will accumlate even more. Thanks for the input.

Steel
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Old 04-13-2012, 06:25 AM   #19
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FWIW, alot like earlier replies...
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No, I do not view the paid off house as a bond. Your house is a shelter. You may count it as part of your net worth, but unlike a bond, it does not generate income for you (unless you rent it out). I view housing as a necessary expenditure.
This is an interesting comment. I have seen other folks who posit the same idea. In one way, i agree with you that your personal home should not be bought with a view that its an investment, however, there is a huge imputed tax free income that is derived from owing your home outight. To me, since you have to live somewhere, it acts like a Muni. Now, If I had bought some sort of huge McMansion, the carrying costs would negate this, but my home is a normal house so since I would either pay rent or a mortgage, paying it off seems like a bond.

I 100% agree that when making a decision to purchase your home, that assuming anything about it appreciating is wrong headed. In fact, technically, its a liability, but a special sort of one

Steel
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Old 04-13-2012, 07:31 AM   #20
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Originally Posted by Steel Rain View Post
All 4 of our rentals are in Montgomery, all withing a few blocks of each other. Its all post war housing, 3 beds 1 or 1 1/2 bath, Oswego 308 schools, so what would be called bread an butters. They have been giving these things away, what we have been doing is buying them at 60ish k each, putting about 10k in, then renting them for about 1400. Seems that with the meltdown, there are tons of renters, so we have been 100 percent occupied for several years. We buy them in cash, then do the work, wait one year and get a fannie may mortgage out for 75% LTV. The net result is we actually put cash in our pocket and still drive 400 mo cash flow. I will take all i can get, but it seems that there are less of them around at the moment. Could be because of the foreclosure slowdown due to robo signing, but we keep looking and can move if we see what we want.

Steel
I am confused by the logic of mortgaging what you paid cash for? Does your debt free status reflect that you have now paid off the 75%LTV mortgage on the rentals?
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