Young guy looking for advice

[jackster1232002]

Hello everyone. I was referred to this site after getting some financial advice from some other forms. So here is my situation:

>25 years old
>current annual income 58k a year
>employer contributes 12% extra of my annual income towards a SEP-IRA (I do not pay a penny)
>Current SEP-IRA has 15k invested
>30k invested in growth and income fund (mutual fund)
>50k in savings


Short term investment plan:
>Purchase move in ready(ish) foreclosed home at 25% under market prices
>Get a 15 year note at a low interest rate (I have dynamite credit)
>Do some light rehab out of pocket while living in it for minimum 2 years
>Sell for profit
>Rinse and repeat

Long term investment plan:
>Start Roth IRA/ Normal IRA in next 5 years when life is more stable and income is higher(married and thinking about kids)
>Switch from growth and income funds to something more stable (advice needed here)
>Continuation of short term investment plan but instead of 2 years switch to at least 5 years as I am more interested in better school districts

Look to retire at age 55 to 65 as rules may change by the time I am ready to retire. Looking at at least 2 mil before I can retire happily with the current and projected inflation rates.

All critique and advice is greatly appreciated!

 

[UserRequested]

Absolutely no standout issues from my perspective. Do question your end goal of $2m though, coz even in today's money I'd be aiming a lot higher. Good luck mate.

 

[CDN_47]

You're way ahead of me when I was 25. Well done! Generous employer contributions and decent savings for your age.

Investing in real estate is probably an OK gamble ... depending on where you live. Just make sure you get a home inspection done ... no matter how cheap the house seems.

Good luck with the plans. Looks pretty solid to me.

 

[pb4uski]

You're doing great jackster!!

I think it would be better to start your Roth earlier rather than later.

I was 100% equities until my early 50s. Your young age is the time to be aggressive investment wise because if there is a market stumble there is plenty of time for recovery. Unless market movements cause you to not sleep at night, I would suggest you remain in growth and income until at least your mid 40s, then put new money into bonds. As a point of reference, the Vanguard Target Retirement 2045 Fund is ~90/10 and I would adjust that to 100/0 right now given the likely performance of bonds for the next 10 years. If market movements cause you to lose sleep at night, then check out Vanguard's Wellington fund which is 65/35 but IMO that is too conservative for your age. YMMV.

While I like the idea of buying the dog of the neighborhood and fixing it up and taking advantage of tax-free gains on the sale of your principal residence, I'm not sure that the opportunities will be robust and I think you will find that living in a project grows old quickly, but give it a whirl and you can always adjust if you don't like it.

I think your $2m target (in today's dollars so it would really be more in nominal dollars) should be plenty as that would give you $70k (in today's dollars) to live on assuming a 3.5% WR. You could model out on a spreadsheet or using Quicken Lifetime Planner what your savings rate would need to be to get there.

 

[Major Tom]

Do question your end goal of $2m though, coz even in today's money I'd be aiming a lot higher. Good luck mate.

We can't really make these kinds of judgement calls unless we know what his desired income in retirement is. A 3% annual withdrawal from $2M is 60K, and a more conservative 2.5% withdrawal is 50K. If that's the kind of income he's looking for, it sounds good to me.

jackster - if and when you buy those houses, make sure you'll be quite content living in them, in case you need to stay longer than 2 years in order to turn a profit. Housing, like equities, does go up over the long term, but can do all sorts of fun things in the short and mid-terms from time to time.

Sounds like you're off to a good start!

 

[jackster1232002]

Thanks for all the replies!

The 2 mil is just a number that my finance professor told me when I was in school. After running some costs analysis, he pretty much right on the ball with that one.

As far as the housing project, I've been living in apartments for the last 8 years. Living in a home again is very tempting for me even if I have to stay longer than expected. More so because I've been wasting all that cash on rent where I could have put it towards a mortgage. And yes home inspection is a must.

From reading a lot of the forums, it seems vanguard is the way to go. Currently my 30k is invested in Growth and Income funds from American Funds. It is actively managed (more costs I know), but I made the investment when I was barely 22. So I was very timid about the decision and wanted as much security as possible. Should I cash out and move to a vanguard mutual fund?

Should I max out the vanguard roth IRA? Or put 50/50 in savings and roth? As you can see I have more in savings than I do in retirement/investment funds. Should I start changing that?

 

[pb4uski]

I would max out the Roth. That way, you'll have a good balance of taxable, tax-deferred (SEP-IRA) and tax-free (Roth) funds.

If you move the American Funds money you'll likely owe 15% tax on any gain so I would figure out what that is before making any moves.

 

[jackster1232002]

If you move the American Funds money you'll likely owe 15% tax on any gain so I would figure out what that is before making any moves.

Wouldn't I owe 15% regardless of when I decide to move it? There is no way out of this correct? Also I am pretty sure I owe another 2-3% as the fund is managed , really wish I just went with vanguard back in the day.

 

[MooreBonds]

Congrats on a good start! I have 11 years on you, and wish I had the intelligence to pursue index funds at your age! (woulda, coulda, shoulda)

About your future house - While I definitely would never advise someone of over-reaching on their home and buying 'the most home you can afford', there are some particular variables at play currently:

-Mortgage rates we very may well NEVER see again in our lifetimes (or, if we do, it'll be when we're 80 and don't need a mortgage). Incredibly cheap loans are not always available. Getting a 30 year mortgage on a larger home you can stay in could be worth it, pending other variables. The biggest is that you are interested in getting married and having kids. School districts and particular opinions of your future spouse are a big one that impact what house you buy ....so your work now may be for naught if your future spouse can't stand your house.

-Transaction costs: because of the sometimes significant costs of buying/selling a home, it is something to keep in mind of staying put in the same house for 20-30 years vs moving around. Everything from closing costs on a mortgage (1%-2% of the loan amount, sometimes more!), 5%-6% realtor commission, the emotional and mental anguish of looking around for your next home (and the headache of paying for and living in a rental if you don't see a home you really like), moving costs (time and $), etc. If you see a great deal for a great house that has a size you could still be in with 2 kids (2 or 3 bedrooms), I'd say give it some serious thought due to both transaction costs as well as likely not having similar opportunities for low interest rates again.

On the 'negative' side, buying a foreclosed home can be very tricky. You wouldn't believe how some previous homeowner's treat their soon-to-be-repossessed home: some people are respectful and honorable, and leave it be. But others do everything from sell appliances (even built-in ovens!) to ripping out copper plumbing to sell for scrap! Buying a foreclosed home can have few problems, or require a TON of work. It can be a great learning experience by remodeling yourself (which is what I did with my 60 year old home I bought, which hadn't been remodeled in 40+ years!), but be careful with taking on too many problems. If the home is structurally sound with just cosmetic updates needed or reasonable kitchen/bathroom remodeling, go for it!

Just remember that your remodeling will likely take longer than you realize. (and if you need any tips on finding great prices on appliances/tile/fixtures/etc, feel free to PM me)

Should I max out the vanguard roth IRA? Or put 50/50 in savings and roth? As you can see I have more in savings than I do in retirement/investment funds. Should I start changing that?

I'm a big believer in diversification - including in taxes. What is your current marginal/highest tax rate? If you're in the 25% bracket, I'd assume that rates will be about the same when you retire (assuming married), or perhaps slightly higher %-wise, so I'd favor putting, say, 2/3 into your ROTH and 1/3 into your 401k.

The reason I'd never put 100% into one or the other (for your situation) is that tax rates are purely a function of politicians, and have nothing to do with 'fairness'. My favorite example: Social security benefits used to be taxed just 50%, the reason being that when you get your paycheck, you're paying income taxes today on the SS money that's deposited into the SS trust fund, while the equal amount your employer puts into the SS trust fund isn't taxed. The theory was that when you draw SS, 50% of what you receive wasn't taxed (the part paid by your employer), while 50% of it was when you earned it, so only 50% of your SS income would be taxed when you retire.

However, about 20 years ago, Washington changed that such that up to 85% of your SS is taxed. So in essence, up to 35% of your SS is being double taxed (once when you earn it, and again when you receive it).

So for those who think "The ROTH is forever tax-free! They'll never tax it!", just look at what politicians were able to do to SS (despite the huge SS voting block), and realize the gov't could easily pass anything they want (asset tax, special ROTH tax, etc.) which might hit a ROTH. By diversifying your taxes, it's just like buying an index fund - you may not reach the stars by having the absolute best possible outcome with the best-performing mutual fund, but you're 'guaranteed' to reach the moon and outperform many other people who rolled the die and picked wrongly by putting 100% of their contributions in the wrong account 20-30-40 years ago.

Having said that, in my particular situation, I'm putting 100% into my traditional 401k at work, because of my current tax bracket and what I expect my tax bracket to be when I retire (less than it is now).

Also, don't forget to make sure you have a good amount in taxable funds that you can access without an issue to fund your lifestyle. Retiring in your 50s would still call for a prudent withdrawal rate of perhaps 3.5%-4%, which would initially come from your taxable funds until you can access your ROTH penalty-free (although you can take contributions out penalty free).

 

[jackster1232002]

Congrats on a good start! I have 11 years on you, and wish I had the intelligence to pursue index funds at your age! (woulda, coulda, shoulda)

About your future house - While I definitely would never advise someone of over-reaching on their home and buying 'the most home you can afford', there are some particular variables at play currently:

-Mortgage rates we very may well NEVER see again in our lifetimes (or, if we do, it'll be when we're 80 and don't need a mortgage). Incredibly cheap loans are not always available. Getting a 30 year mortgage on a larger home you can stay in could be worth it, pending other variables. The biggest is that you are interested in getting married and having kids. School districts and particular opinions of your future spouse are a big one that impact what house you buy ....so your work now may be for naught if your future spouse can't stand your house.

-Transaction costs: because of the sometimes significant costs of buying/selling a home, it is something to keep in mind of staying put in the same house for 20-30 years vs moving around. Everything from closing costs on a mortgage (1%-2% of the loan amount, sometimes more!), 5%-6% realtor commission, the emotional and mental anguish of looking around for your next home (and the headache of paying for and living in a rental if you don't see a home you really like), moving costs (time and $), etc. If you see a great deal for a great house that has a size you could still be in with 2 kids (2 or 3 bedrooms), I'd say give it some serious thought due to both transaction costs as well as likely not having similar opportunities for low interest rates again.

On the 'negative' side, buying a foreclosed home can be very tricky. You wouldn't believe how some previous homeowner's treat their soon-to-be-repossessed home: some people are respectful and honorable, and leave it be. But others do everything from sell appliances (even built-in ovens!) to ripping out copper plumbing to sell for scrap! Buying a foreclosed home can have few problems, or require a TON of work. It can be a great learning experience by remodeling yourself (which is what I did with my 60 year old home I bought, which hadn't been remodeled in 40+ years!), but be careful with taking on too many problems. If the home is structurally sound with just cosmetic updates needed or reasonable kitchen/bathroom remodeling, go for it!

Just remember that your remodeling will likely take longer than you realize. (and if you need any tips on finding great prices on appliances/tile/fixtures/etc, feel free to PM me)

Those are exactly the homes I am looking at. Structurally sound with some cosmetic updates. Been looking at some with some bad roofs, but I always have a roof guy come in to take a look before making a bid.

I'm a big believer in diversification - including in taxes. What is your current marginal/highest tax rate? If you're in the 25% bracket, I'd assume that rates will be about the same when you retire (assuming married), or perhaps slightly higher %-wise, so I'd favor putting, say, 2/3 into your ROTH and 1/3 into your 401k.

The reason I'd never put 100% into one or the other (for your situation) is that tax rates are purely a function of politicians, and have nothing to do with 'fairness'. My favorite example: Social security benefits used to be taxed just 50%, the reason being that when you get your paycheck, you're paying income taxes today on the SS money that's deposited into the SS trust fund, while the equal amount your employer puts into the SS trust fund isn't taxed. The theory was that when you draw SS, 50% of what you receive wasn't taxed (the part paid by your employer), while 50% of it was when you earned it, so only 50% of your SS income would be taxed when you retire.

However, about 20 years ago, Washington changed that such that up to 85% of your SS is taxed. So in essence, up to 35% of your SS is being double taxed (once when you earn it, and again when you receive it).

So for those who think "The ROTH is forever tax-free! They'll never tax it!", just look at what politicians were able to do to SS (despite the huge SS voting block), and realize the gov't could easily pass anything they want (asset tax, special ROTH tax, etc.) which might hit a ROTH. By diversifying your taxes, it's just like buying an index fund - you may not reach the stars by having the absolute best possible outcome with the best-performing mutual fund, but you're 'guaranteed' to reach the moon and outperform many other people who rolled the die and picked wrongly by putting 100% of their contributions in the wrong account 20-30-40 years ago.

Having said that, in my particular situation, I'm putting 100% into my traditional 401k at work, because of my current tax bracket and what I expect my tax bracket to be when I retire (less than it is now).

Also, don't forget to make sure you have a good amount in taxable funds that you can access without an issue to fund your lifestyle. Retiring in your 50s would still call for a prudent withdrawal rate of perhaps 3.5%-4%, which would initially come from your taxable funds until you can access your ROTH penalty-free (although you can take contributions out penalty free).

I don't have a 401k. My employer contributes to my SEP-IRA (12%) completely and I am unable to add into it. So would I from your suggestion contribute 33% to a traditional IRA and 66% to a ROTH IRA?

 

[Animorph]

I would max out the Roth IRA for as long as you remain in the 15% tax bracket and stay below the income limit. That may not be as long as it seems, this is a limited time window. After that use the tIRA if it is deductible for you. I see no reason to mix tIRA and Roth IRA. Your SEP-IRA is doing the tIRA part for you. Your tIRA/SEP-IRA will probably greatly outweigh your Roth accounts by the time you retire. Then you can Roth convert when your taxes are low once again.

 

[Rothman]

If employer does sep IRA then your money could go to Roth IRA for the diversity mentioned. I. Also go all equities with a long time horizon like yours. Key is to avoid temptation to pull money or borrow from funds so they can grow and compound your returns. Congrats again on great start.

 

[nash031]

Hello everyone. I was referred to this site after getting some financial advice from some other forms. So here is my situation:

Short term investment plan:
>Purchase move in ready(ish) foreclosed home at 25% under market prices
>Get a 15 year note at a low interest rate (I have dynamite credit)
>Do some light rehab out of pocket while living in it for minimum 2 years
>Sell for profit
>Rinse and repeat

Good luck. While the market is ripe for this kind of thing now, it can change quickly. I am on my third "short term" home purchase, having owned the previous two for about 2 years each. Doesn't always work as easily as "sell for profit"!

 

[target2019]

There are calculators online where you can measure the difference given up when fees increase. I have this in my spreadsheet to remind me. Find the difference between your American Fund and a comparable index fund. If your active fund can out-perform an index fun for 30 years, maybe your G&I fund is worth it. My guess is no...

Over 30 years, a .75 difference in expenses can be -18.56% given up from the total. Something to think about.

This calculator only goes to 20 years, but it shows the impact of sales fee also.

 

[jackster1232002]

Good luck. While the market is ripe for this kind of thing now, it can change quickly. I am on my third "short term" home purchase, having owned the previous two for about 2 years each. Doesn't always work as easily as "sell for profit"!

What difficulties did you have to go through so I don't make the same mistakes.

 

[jackster1232002]

Argh I can't believe I forgot to ask this. Lets say I get a 100k home with 20% down with the current rates of either 4.5 for 30 yr note or 3.5 for a 15 year note. Which one should I choose? Keep in mind the monthly difference is only 150 dollars a month.

On one hand I pay more interest but I have more cash on hand to invest more into a rIRA or tIRA/ mutual fund. On the other hand I pay less interest towards the bank.

 

[pb4uski]

Wouldn't I owe 15% regardless of when I decide to move it? There is no way out of this correct? Also I am pretty sure I owe another 2-3% as the fund is managed , really wish I just went with vanguard back in the day.

It depends. If you have other taxable investments that you have losses on you could offset. Or if you are unemployed for a period (or retired) and your income is in the 15% bracket the long term capital gains rate is 0%.

 

[chasesfish]

Lots of posts already.


I have a couple of questions:

I used to have a plan like this, but my wife wasn't on board with buying 3/2 brick ranches and working on them while living there. Are you 100% sure she's on board?

Why sell the property and not keep it a a rental?

I'm a fan of 15yr mortgages.

If the others weren't clear enough, Roth Roth Roth.

Then go and sell those American Funds and buy the Vanguard Wellington Fund. 1/2% per year in fees over a lifetime is a ton of money to give away

 

[MRG]

Then go and sell those American Funds and buy the Vanguard Wellington Fund. 1/2% per year in fees over a lifetime is a ton of money to give away

Did the OP say what class of American funds these are. You may have some "deferred sales fees", AFS makes use of these and I think they run the maximum 7 years. Not saying you shouldn't move to Vanguard, just understand what it will cost in fee's that may have been agreed to.

I'm not suggesting anything bad about American funds, or you're choice to go there when you did. Wish I had been as financially aware as you at your age. You're off to a great start.

MRG

 

[Sesq]

I know a few contractors/builders who did the build/remodel, wait two years, sell routine. Eventually their spouses put an end to it (moving sucks).

That said, why bother with 15 year notes if you plan to sell w/i a few years. The payment inflexibility would seem to run contrary to the need to cashflow your remodel expenses. I'd go penfed 5/5 ARM all the way.

I think the uglier the house the bigger your profit will be. I'd work up your DIY skills.

 

[nash031]

What difficulties did you have to go through so I don't make the same mistakes.

A few things I would do differently:

- I would try to do more of it on my own, especially in a market like today's. While I got a "relative discount" for my full-service RE agent (5%, instead of 6%), I don't think the process is so hard to understand/execute that I need to pay that much to sell. In fact, when I have bought, I end up doing quite a bit of the legwork anyway, and the agent just helps find properties, showings, etc., in areas with which I am unfamiliar.

- I would be much more in-tune with the market and the area, its history and its future. In short-term purchases (speculation, really), you are dependent on the demand for that property in the near term, and not very concerned about growth in value. You're looking to sell something whose value doesn't really change over the short term, but yet whose price is driven up by demand for whatever makes it desirable. For example, I would never buy in an area that was being newly developed if it was a short-term (less than ten year) purchase. The condo on which I lost $30,000 was on a small island that was being developed and had hundreds of similar units, with more being built. Mine didn't stand out, and no amount of upgrading was really going to change that. If someone wanted in, they had a whole slew of new-construction options that were going to command less than I wanted to sell my place for. That market was hit hard by the bubble burst. On the house where I made $60,000 in two years, it was a new construction when I purchased, but was in a desirable area that didn't have a lot of newly developed areas or housing growth, so the price I was able to command wasn't submarined by new construction or similar, lower priced options. (I am currently in an ideal situation for that as well, living on an island with lots of old housing and next to no housing growth, just remodeling, thus demand is always there).

- I think there's a lot of value in holding property on the low-end of the price range in highly desireable areas. I own a house now that is the least-expensive stand-alone house model on the island. Anything less expensive is a part of a multiple unit building/townhouse. When we bought it, there were two contingent offers, and that was two-plus years ago when the market was down. Again, on the condo where I lost money, I was at the higher end of the available market on that island.

- Always remember that housing prices don't HAVE to go up, even on foreclosures (though a foreclosure is usually a better value). There's this assumption in the US that a house will always gain value. That holds true over the long term, as housing tends to be good inflation protection if you view it as an "asset" (which is debatable). But in the short term, RE can be very volatile. I wouldn't engage in "flipping". About as risky as I'll get with RE is shorter-term purchasing of homes in which I intend to live for less than five years.

- I look for quicker ways to build equity and minimize my costs. This specific example may not apply to you, but in the case of my current home, I put 20% down, maxed out a "regular" mortgage at $417k (rather than financing a "jumbo") and then used that equity from the down payment to get another Home Equity loan to cover the rest. Mortgage rate was 4.6% (I have since re-financed with the PenFed 5/5 for around 3.2%), but the HE loan was more like 8%. I paid that HE off in about six months, and made just the minimum payment to the mortgage. Now, with the refi and the HE loan paid off, I am paying extra toward principle, again as an inflation hedge (and because I just don't see a whole heck of a lot of investment opportunities out there that I like right now, and I have good emergency funds and "opportunity cash" on hand already).

- Never use Interest Only ARMs. (I never did, but never would, either!)

That's my 20 cents' worth of experiences over three home purchases in my 20's and 30's.

 

[nash031]

Argh I can't believe I forgot to ask this. Lets say I get a 100k home with 20% down with the current rates of either 4.5 for 30 yr note or 3.5 for a 15 year note. Which one should I choose? Keep in mind the monthly difference is only 150 dollars a month.

On one hand I pay more interest but I have more cash on hand to invest more into a rIRA or tIRA/ mutual fund. On the other hand I pay less interest towards the bank.

I chose to do a 30-year initially, but refinanced to the PenFed 5/5 with no closing costs. If you can afford it, I would choose the lower interest rate so that you're not stuck with something you don't want and either (a) have to sell when you don't want to; or (b) are forced to pay to refinance in the future.

There are calculators out there that can help. The general rule I usually follow is that over the time I intend to hold that loan, if I think I make more on an investment than I would paying down the loan (i.e. make >4.5% on an investment over five years that I hold the 4.5% loan), then I go with that option. In my most recent purchase, I went with the 4.6% 30-year initially, and used any remaining cash to invest. Two years later, I've re-fi'ed and am paying 125% more principal every month while still paying the same amount toward the house.

 

[Snoozie]

Great job!! Be sure to look at a great, inspiring blog, too - Mr. Money Mustache - he's always got great ideas!!! I think you'll love him - he's a young whippersnapper, too!