The following is a guest post from Chris, a fella I met while stranded in Frankfurt, en route home from my business trip to Switzerland and Mallorca to do more research on the happiest countries in the world. Chris has a dilemma and could use the community’s help! – Sam
It was early evening when the airplane broke so the airline had to put up all of the passengers in a local hotel – to make matters challenging we were unable to get our checked luggage and had to survive on the contents of our carry-on bags. Upon entering the lobby I quickly noted that the hotel check-in line was 17 passengers deep so I decided to “wait” in the hotel bar (which was oddly empty) while my fellow, disgruntled travelers begged for rooms. Another fellow passenger noted the length of the queue and opted for the bar seat right next to me.
My bar partner and I got to drinking, laughing, and chatting about possibly catching a cab into town to procure clean under-garments – I don’t recall how long we sat at the bar, the check-in line was non-existent by the time we got room keys, my decision-making was “gin and tonic clouded” and I was happy that I chose to spend the time making a new friend instead of wasting time in a check-in line. My bar partner was Sam, he told me about his FS journey and I’ve been a regular visitor to the FS site since.
MAKING A CHANGE IN LIFE AND ALLOCATION
I recently got divorced (sidebar: not something I recommend – ugly process and expensive). Coming out the other side I reassessed my financial position to make sure I was on track to maintain a decent lifestyle and plan for my formative years.
As part of my assessment I used a lot of the charts on the FS website: income, net worth, 401k balance…. check, check, check – and felt pretty good about my newly-single, financial situation. Then I read the “Recommended Net Worth Allocation By Age and Work Experience” article and found myself darn near hyperventilating.
My “Base Case” Net Worth Allocation (@ 45 years old) recommendation is:
40% Stocks, 20% Bonds, 30% Real Estate and 10% Risk Free
My actual Net Worth Allocation was:
30% Stocks, 10% Bonds, 55% Real Estate and 5% Risk Free (85% allocation to stocks and real estate)
So I first questioned how the hell I got in this allocation mess, and secondly and more importantly, how I could get my allocation corrected.
When I was married my wife and I made good money, maxed out our 401k’s every year, paid off the mortgage on our primary residence in Pleasant Hill in 15 years, drove 5-10 year old cars and even worked part-time jobs (generating another $60k/year) as extra financial padding.
When the Global Financial Crisis occurred we had no debt, a fair-size pile of cash and relatively secure careers. Real estate was cheap so we bought two rental properties – a condo in Modesto (I took a new job in Modesto and thought I might need a place to stay a few nights/week) and a condo in Benicia with an amazing view of the Carquinez Straits.
When we got divorced the goal was to split our assets 50/50 – once she decided she definitely wanted the Pleasant Hill house I simply moved assets around on an Excel spreadsheet until we were “equal.”
She got: the Pleasant Hill house, her retirement savings and a bunch of cash. I got: the Benicia and Modesto rental properties, my retirement savings, and some cash. By focusing on simply splitting assets “equally” I missed the asset “allocation” portion and thereby created my current Net Worth Allocation mess.
Since I was working in and around Modesto I opted to relocate to the area. My Modesto rental property had been rented to a family, so here I was in a new locale, with a new marital status, another new job and nowhere to live. Feeling like I’d endured enough “new” stuff for a while I hunkered down for a year in a cheap, dumpy, little apartment in Turlock to give myself some time figure out my financial future.
FIGURING OUT WHAT TO DO WITH MY PROPERTIES
My first consideration was what to do with the Benicia rental; with good cash-flow, no mortgage, solid appreciation, a property manager that kept it rented to credit-worthy renters for 4 uninterrupted years and a fat depreciation expense to keep income taxes reasonable, deciding to keep it was a no brainer.
My next considerations were what to do with the Modesto rental and where to live, I boiled it down to 3 options:
Option #1: Move into the Modesto rental for two years and avoid capital gains if I decided to sell it later. There was to fair bit of crime in the Modesto complex, the unit did not have a garage, the unit was small and you could literally hear the neighbors breathing due to lack of sound-proofing in the walls between the units.
Option #2: 1031 exchange out of the Modesto rental into another property more suited to my new life. A tricky option because I would have had to find the right exchange partner and after a cursory review of the costs, confluence of events that I’d need for this to work I decided this option would take far, far too long.
Option #3: Sell the Modesto rental property, get body-slammed on capital gains taxes and roll the profits into to new place to live.
I opted for #3, sold the Modesto rental for a solid 30% profit and then bought another condo in Modesto that I absolutely love. The Cap Gains on the 30% profit on the Modesto rental hurt (like, $12k hurt) a bunch – oh well, the best part of paying taxes is that you know you made money, right?
Back to my solving Net Worth Allocation situation – I could sell the Benicia rental for a solid 35% profit and use the proceeds to buy other non-Real Estate assets which will resolve my Net Worth Allocation problem. The downside is that I’ll get killed on Cap Gains (a massive transaction cost on post-tax dollars that I don’t want to repeat) and lose the rental income. That seems like a heavy cost to become diversified.
FIGURING OUT A PLAN
Well, I’ve decided to make zero changes and leave my Net Worth Allocation way out of whack for the time being. My plan/thinking is this:
Stocks/Bonds/Retirement: I have 15+ years to make more money and max out my 401k – on current pace of funding my retirement and buying mutual funds with post-tax money I’ll get close to a proper Net Worth Allocation when I near retirement age
Real Estate: I currently have too much real estate exposure so I won’t be buying additional rental property.
Risk-Free/ Cash: I regularly over-pay my current Modesto mortgage by 33-50% each month in hopes of retiring my 30-year note in 10-15 years. Instead of over-paying my mortgage I could simply make the minimum mortgage payment and use the extra cash to build my cash reserves, buy mutual funds, whatever – I hate mortgage debt and I’m undecided on that part of equation.
In the short-term I’ll pray each and every day that the bottom doesn’t fall out of the Northern California Real Estate market like it did in 2007/2008 because a massive down-turn in real estate values will blow a massive hole in my undiversified portfolio.
That’s my story, I hope you find some value in my tale and look forward to reading the feedback from other FS followers. Be well. – Chris
* Track your net worth for free. The best way to manage your net worth is with Personal Capital’s FREE financial tools. I’ve been using them since 2012 and have seen my net worth zoom higher thanks to better net worth management. They have an amazing Retirement Planner, Portfolio Fee Analyzer, and awesome cash flow management tools. It’s free and takes only a minute to sign up. Link all your accounts to get the maximum use of the application.
Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.
Updated for 2019 and beyond.