At What Cost Is Net Worth Diversification Worth It?

Net Worth DiversificationThe 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.


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.

Map of the San Francisco Bay Area And East Bay

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.


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.


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


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31 thoughts on “At What Cost Is Net Worth Diversification Worth It?”

  1. Hey Sam – love the site. Got me really focused on ensuring I do a decent job of developing my net worth in the long term. This guest article was really interesting too. I had a question about asset classification. Would you consider REITs as purely stocks, or some hybrid of Real Estate and Equity?

  2. Moving from Pleasant Hill to Modesto doesn’t sound very appealing unless the economic opportunity in Central Valley is just too good to pass up. In regards to stocks, real estate, and diversification, the answer all depends on how wealthy someone wants to become and what sort of lifestyle they want to live. For most working folks, I like Sam’s suggestions on diversification. But to become over $10 mil rich, most folks need to concentrate their resources instead of diversifying.

    1. I agree 100%. Diversifying is a means to protect wealth. I feel you need to focus your wealth on one classification. Masters receive disproportionate results and you can’t be a master in all things. If you are astute in real estate creating large gains then you take your gains and use them as a tool to further your wealth in that same asset class. Diversification can come from out of state investments or adding commercial real estate.

      Once you reach your level of comfort you begin to diversify.

      Just my .02

  3. carlos hernandez

    I enjoyed reading of Chris’ financial analysis to his life post the divorce which was very costly from an emotional and financial standpoint. We sold our primary residence last year and started to rent after being long time home owners. I have to say it is a great feeling not to worry or BUDGET for maintenance issues like roof, paint, HVAC etc. I know the great American dream is to home ownership but I am beginning to think it is very over rated and over sold. We live in the Midwest & housing has only appreciated 2-3%/year and the cost of ownership is much more than that with taxes and maintenance. We do own a rental property in Hawaii that has much greater appreciation so that composes our RE portion on the allocation. Aloha!

  4. Fascinating! Thanks for sharing your story. I think you made a good move not to sell the second property and have to pay more capital gains. Your thought process on reducing your mortgage payments and putting more cash into the markets is a good option, especially if you have a good rate on that mortgage. You’d have to run the numbers, but putting money into the market could compound and grow larger and put you further ahead than if you were simply focused on paying down that mortgage debt. I read retirement articles all the time that highlight how investing early can make such a big difference over time versus waiting and investing the same amount much later (assuming equal returns). Here’s hoping the property market continues to do well!

  5. Nice article. I hope you keep us updated in the future. I’d love to hear more readers’ personal finance stories.

    I feel like the paid for rental in Benicia is almost in the risk free category. You stated its never had a vacancy in 4 yrs. Also consider that in the downturn in 2008 rents only went down a small percentage. It doesn’t matter if the value of the condo fluctuates as long as rent is steady. Since this property is paid for your only risk would be a large special assessment. With no mortgage, a short term vacancy is not a problem for you.

  6. I am not sure if Sam covers this somewhere, but one of the things that should absolutely impact % allocation regardless of age is your net worth relative to the number you need to live comfortably. If you are 45 and your assets can produce enough income to let you live comfortably, why risk it? Even if that means you are 20-30% stocks…

    I listened to a radio program the other day explaining how foolish it would be to pay off your mortgage if your rate was “only” 4.75%, because you can “for sure” make way more than that in the market. All i could do was shake my head, it was like hearing somebody getting fitness advice from the fat kid.

    1. I’d pay down a 4.75% mortgage all day long with the risk free rate currently at 2.1%.

      Give me a steady 4%+ net worth return every year and I’ll be happy to pursue what I can control: a business.

        1. That rate is hard to say. Probably not. I AM paying off a 3.35% rental property mortgage now this year b/c I’ve had it for 12 years and thought I’d have paid it off by 10 years.

          2.75% is so low…. I’d follow the FS-DAIR rule!

  7. Divorce is tough. Glad your divorce was handled sort of sensibly.

    Sounds like you already know the answer to your net worth diversification dilemma. Pay less on your mortgage each month and more into equities. If you think your new equity selections each month can out perform the interest on your mortgage then go for it. Eventually your ratios will change if you do that.

  8. The Money Spot

    Interesting perspective, right now my net worth is 86% stocks and 12% real estate and 2% risk free cash. One thing I will be looking into going forward will be possibly increasing my risk free cash position. I do not like having money sitting there not working for me. But having risk free cash available without a doubt will put me in a better situation financially should an emergency arise.

    Thanks for sharing,

    The Money Spot

  9. Capital gains when selling real estate are certainly a bear.

    My wife and I were discussing that same topic for when we move from the bay area back east. Timing on a 1031 exchange is always difficult, or so I hear, but our primary blocking issue is the value requirement. With the high property prices here, the only way we’d find a property of same or higher value to qualify, it would have to be a mansion, or a multi-unit complex, neither of which we want.

    I forsee some high capital gains tax payments in our future as well. But as you, it’s a good pain, at least you know you made some money, even if you don’t get to keep it all…

  10. @Chris: I think you’re being much too hard on yourself and haven’t done so badly at all. Firstly I’d suggest not getting married again! You’re definitely overweight real estate and realize you shouldn’t buy more, but agree that you don’t necessarily need to sell. Regarding future allocation between stocks/bonds/mortgage/cash, before making concrete suggestions I’d need more info. For example, how much longer do you want to work? When do you expect to begin drawing on your assets? What’s your mortgage rate and is refi an option? Unlike you, I love mortgage debt because it’s really cheap (at least here, ~1.5%), and I can easily earn over double that just with stock dividends regardless of capital appreciation.

    For comparison purposes, I’m a 35 year old semi-retired independent IT consultant living in Europe, ~€650K net worth, 70% stocks (40% Europe, 45% US, 15% other), 25% real estate, 5% risk free.

  11. BE Pennypacker

    Fun. I’ve never tried to break out my net worth like this. My current allocations are 42% stocks, 0% bonds, 45% real estate, and 13% risk free. The base-case for someone like me @35 is 50% stock, 10% bonds, 25% real estate, and 15% risk free. Even though my numbers don’t quite match up, I’m pretty happy with where I am. My two main areas of focus right now are paying down my mortgage and investing in stocks for the long haul. Once the mortgage is gone, the plan is to shave a little off of stocks and real estate and start sprinkling in some x factor.

  12. Hi Chris,

    I offer a more contrarian perspective in that I see your Net Worth Allocation is by no means a mess. Diversification is a hedge against near term volatility, whereas your experience in Real Estate and duration to retirement should promote far heavier investment into that sector. I argue that’s where you can achieve superior returns assuming active management, scaling up your Real Estate portfolio consistent with stress-testing against a downturn.

    My expertise is in Stocks (I’m of a similar background to Sam having left the industry after a 15 years in equities analysis), so I am far more comfortable skewing that way with my only exposure to Real Estate being the family home.

    1. Loser 2 Winner

      I was just about to say the same thing.

      I wouldn’t sell good Real Estate just to shift a few percentages in diversification.

      1. Moved from Australia to Oregon about a year ago. Am spending ~4 or so hours a day researching stocks/investments and the remainder of the time enjoying my family & friends and the Oregon outdoors. I’m sure you will agree Sam that when you are working for yourself without meetings or memos to write, then productivity is substantially increased.

        My investing exposure is still nearly all cash as I’m a little cautious on valuations right now, so it will probably take a couple of years to get fully invested with stocks I’m comfortable with. At this stage of my life (mid 40’s) I’m more concerned about preservation of my Nut than growing it as fast as possible.

  13. Thanks for sharing Chris. Is there any opportunity to refi your Modesto note to a lower rate and/or shorten to a 15 year? Have you looked at what your monthly obligation might be with today’s rates?

    When you over pay your mortgage, the return is risk free and equal to your interest rate. An option might be to revert to minimum payments and stack cash for some predetermined amount of time. At the end of that period you could put cash towards a principle payment if you see it as the best opportunity at that point. Building the cash would have bought you extra flexibility if something neat caught your eye in the interim.

  14. Justin Williams

    Great moves so far. I would have done the same. I think that you should get over having mortgage debt depending on what rate you have the money borrowed at. I have been using “rate arbitrage” with my properties for about 10 years and have done very well. I hate cash reserves and would much rather have money riding on AAPL for example, paying a dividend. Whenever I have an extra dollar, I need to assess where I want to put it. Sometimes mortgage debt, sometimes my brokerage account, etc. Great Work !

  15. Chris, you are a very good storyteller and writer. Thanks for sharing this story. Your ‘problem’ is a good one to have, as you noted. One thought that might make you more comfortable with your allocation in real estate is to separate the “built equity” (appreciation/depreciation) from the “debt equity” (outstanding loan amount). This is useful particularly when retiring the debt; the amount is fixed no matter the market appreciation/depreciation, the rate is higher than any risk-free rate, and there is no alternative except to triage another investment choice against that “debt equity”. In example, each dollar you pay against mortgage principal would then count in your ‘risk-free’ allocation instead of ‘real estate’. With your cashflow and salary savings, you can work the rest of your desired allocation.

    Not giving you any financial advice, as you are doing quite well, but my observation at the moment is that ‘risk-free’ investments actually pay more than bonds; bond funds have appreciated only because of decreasing rates and artificial Fed intervention and the only way further appreciation would happen is if there were more cuts. Any increase in rates would result in bond fund depreciation, which has only happened briefly and temporarily in the past 30+ years. I combine my ‘bond’/’risk-free’ allocations, maybe that might work for you. In any event, you are doing great and hope you will continue to share from your journey.

  16. Interesting story. I commend you for being so real.

    In the summer of ’14 I was convinced that there was a crash coming in oil. I sold all of my Exxon and bought puts on two companies through December and January respectively. I was 100% wrong because one company was purchased at the most prescient time imaginable in October and the other has had an unexplainable buoyancy.

    Now, i am >80% cash with a long put on a triple leveraged S&P ETF. In December I converted all of my 401K’s to money market.

    I think there is a crash coming and you should monetize your assets. NoCal RE is a bubble dude. Think to yourself, how real is twitter?

    1. Wow, you’re one of the most bearish folks Austin! Chris’ area isn’t actually considered NorCal. It’s more Central Valley, Sacramento area. I still think San Francisco real estate is cheap on an international stage.

      I’ve thought about selling at least one property and cashing in. But every time I do, I think about the horrendous 5% commission I’ve got to pay on a artificially controlled industry.

      I am on STRIKE and plan to NEVER sell any real estate so long as commissions stay so high. The internet has lowered the cost of everything, except for real estate selling commissions. It’s ridiculous.

      1. I think it’s heading that way, Sam, but I’m right with you. 5 or 6% commission is CRAZY.

        I’m debating whether to rent or sell my current townhouse when we move to a single family home here in Northern Virginia. Would love to hang on to it as a rental, but then I’m carrying a lot of real estate.

        If I do sell, I’m looking hard at sites like Redfin that offer discounted commissions (I think Redfin is 1%, plus whatever is offered to the buyer’s agent).

      2. There is a company that is working on lowering the cost of selling your home using the internet and your smart phone…

  17. I find myself not diversified enough as well. Our house and the equity in it is our only real estate. Most of our money is tied up in my 401k between stocks and bonds.

    I think over the next 5 years or so the plan is to pay down the mortgage as much as possible, like you stated. This will help add to my real estate position. Buying rental properties isn’t in the cards right now, though I suppose I wont rule it out down the road.

    Good story meeting Sam and receiving some of his tips most likely!


  18. I’m about to turn 35 and I’m almost 100% in stocks. No real estate because I live in the NYC metro area and I don’t even want to deal with that. My neighborhood has the highest property taxes in the country. No kids, no debt, so my husband and I figure what the hell, we’re young enough to ride another downturn with our stocks. Right now I’m working on building up a lot more cash because I want to start my own business someday. So our stocks are just sitting there for now while we grow our cash.

    1. 100% net worth in stocks is incredibly aggressive. But, given no debt and no dependents, you’ll probably be fine. The only problem with a large stock downturn is that paycuts and job losses will ensue given corporate profitability is declining.

      Furthermore, I like to always have hope that all of us will be able to convince a partner or spouse to work longer so we can retire earlier. :)

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