Slicing Through Money's Mysteries
Phew! We made it! What a year 2020 has been. I’m absolutely exhausted from taking care of my two young kids, experiencing so much uncertainty, and writing so much.
Unfortunately, the first half of 2021 likely won’t be much different. Many cities and counties will still be under shelter-in-place. Most of us still won’t get vaccinated. And the fear of the virus will remain. Yay.
All the same, I’m looking forward to better times in 2021. But first, here’s my 2020 year in review.
I’m bullish on real estate in 2021+. With multiple efficacious vaccines, an accommodative Fed, continued low mortgage rates, another round of stimulus, work from home here to stay, the desire to own income-producing assets, and pent up demand, real estate has a bright future. Here is the latest Fundrise overview.
Fundrise is a leading real estate crowdfunding platform for non-accredited and accredited investors. Founded in 2012, Fundrise pioneered the eREIT asset, a private diversified real estate investment trust that enables everyday people to invest in private real estate once reserved for ultra-high net worth individuals or institutions.
Currently, Fundrise manages over $1 billion in equity and has over 130,000 investors on its platform. Due to the private nature of its investments, there is less visible volatility on a day-to-day basis. Further, historical returns have stayed relatively consistent, despite the stock market gyrations. Of course, past performance is no guarantee of future performance.
For those of you looking to diversify into real estate passively or increase your real estate exposure, here’s an interview with Ben Miller, Founder and CEO of Fundrise.
Not only do I appreciate the innovation that has come out of Fundrise since the company began, I also appreciate their investment analysis and annual market outlook. Their focus on market fundamentals is something I really appreciate. Their investment philosophy is also aligned with my own. Fundrise is a gracious sponsor of Financial Samurai.
One of the keys to being a successful landlord is finding good tenants. At some point in your landlord journey, you may come across a situation where you have to decide between better tenants or higher rent. Of course, in an ideal situation, you would love to have both.
This post will share my latest tenant search experience. I’ll give you some things to think through if you ever come across this dilemma.
In a previous article, I highlighted the negatives of early retirement nobody likes talking about. It might have seemed like the negatives of early retirement outweighed the positives, but I assure you that’s not the case at all. There are some surprising benefits of early retirement I never anticipated as well!
Retiring early has by far been my “best career move.” Originally, I thought I would just live a frugal lifestyle off of roughly $80,000 a year in investment income in 2012.
My wife joined me three years later when she also turned 34 so we could both live free and frugal together. We thought we’d rent or buy a small two-bedroom, one-bathroom apartment near or on the beach in Hawaii and live out our remaining days.
Instead, our lives turned out a little differently. We actually have grown our net worth and our passive income to a level we did not thought possible partially due to early retirement.
Let me share with you all of the surprising benefits of early retirement I never anticipated.
Personal Capital, a digital wealth advisor with over 1.5 million users of its free financial tools, released its latest Affluent Investor report. Among other things, it highlights the biggest financial concerns of affluent investors.
The biggest surprise from one of its surveys is that folks with more than $500,000 in investable assets are most worried about a financially secure retirement. Think about that for a minute. With the median retirement savings for 56 – 61 year olds in America at only ~$20,000, Americans with 25X that amount cite financial security as their top worry!
With $500,000+ in investable assets alone, one can presume that most survey respondents have net worths in excess of $1,000,000. After all, about ~85% of the typical American’s net worth is tied up in their primary residence. Check out the survey results.
Accurate passive income forecasting is important for tax minimization, better time utilization, stronger mental health, and increased overall happiness.
For 2020, I made a big mistake by inaccurately estimating my passive income. At the beginning of 2020, I estimated I would earn roughly $70,000 from my various real estate crowdfunding investments. The combined estimate for all my passive income sources would be roughly $265,000.
Instead, by November, I had already received $226,600 in real estate crowdfunding distributions, alone. Although it’s nice to make more money than expected, you don’t want to make so much more that your taxes get blown up.
It is unclear yet how much of the $226,600 in real estate crowdfunding distributions is capital gains versus original principal. It certainly can’t all be taxable capital gains.
However, there’s wording in my investment dashboard that says “Earnings excluding principal.” If this is true, then my unanticipated extra tax liability for the year is going to be at least $50,000.
Paying an extra $50,000 in capital gains taxes on top of already paying a hefty amount in property, federal income, state income, and FICA taxes is a real kick in the shins. Yes, paying lots of taxes is a good way to help society. However, bad financial planning is not the Financial Samurai way.
If I had planned better, I could have cut the $50,000 tax liability probably in half. This would have been possible by paying myself a lower salary, investing in more growth stocks instead of income-producing assets, and increasing business capital expenditure.
Thankfully, the year isn’t over yet! Further, I’m pretty sure a good chunk of the $226,600 isn’t profits. I’ll just have to wait until I get my K-1 to see.
Let’s talk more about the importance of accurate passive income forecasting for financial freedom.
Passive income should be your #1 source of income in early retirement. Think of your passive income as your core life force. All other income sources are supplementary, including forcing your spouse to keep working long after you hang up your boots.
If you have enough passive income from your investments to cover your desired living expenses, you are financially independent. There is no other appropriate definition, no matter how many impatient souls try to redefine financial independence.
As you advance in your financial independence journey, you will calibrate the ideal income you need to live your best life. You will then take the appropriate steps necessary to get there.
Before I had children, I thought the ideal household income for my wife and I was $200,000. $100,000 for me, $100,000 for her. Equality is so simple. $200,000 wasn’t as much as what we were making combined at our full-time jobs. But the lack of income was more than made up by our abundance of freedom.
Once we had our son, we bumped up our ideal household income to $250,000. $100,000 for me, $100,000 for her, and $50,000 to cover all our son’s living costs. The figures seemed reasonable after running the numbers.
Then once we had our daughter, we bumped up our ideal household income to $300,000. $100,000 for me, $100,000 for her, $50,000 for him, $50,000 for her. Again, equality for everyone.
Although my passive income goals seemed logical to me, there was a lot of uproar after I published a post about living a middle-class lifestyle on $300,000 a year. The budget and income weren’t specifically ours in the post. But it was similar to our ideal early retirement lifestyle.
There was anger at the idea that a middle-class family deserved to own a house, have two kids, afford college, and save for retirement in a big city. It was interesting how some of the critics couldn’t reconcile cost of living differences across the country. Therefore, I mentally throttled back my passive income goals to avoid further backlash.
I felt bad and maybe even embarrassed for wanting to earn $300,000+ in passive income to take care of my family. When I had a $250,000 passive income goal, I didn’t get a lot of backlash. Therefore, I decided to mentally revert back to the $250,000 figure instead.
By focusing on $250,000 as a more reasonable passive income goal, I failed to properly forecast the likely future returns of my investments. At the end of 2016, I had made $260,000 worth of real estate crowdfunding investments.
I then invested another $550,000 in real estate crowdfunding in 2017. The funds came from selling my rental property in San Francisco to simplify life. Managing a rental with five guys when I had a newborn was too much.
On average, the investment terms of my 17 real estate crowdfunding investments ranged from 3 – 5 years. Therefore, it would make sense that starting in 2020, a significant portion of my capital and profits would start getting distributed.
Even just estimating a 20% return on an $810,000 investment would equal $162,000 in profits. Instead, I estimated just a 8.75% return.
Further, because of the pandemic, I had my doubts that any capital would be returned. A more probable investment scenario would be a 12-18 month delay in distributions until 2021 or 2022.
However, as I learned in my November 2020 review, Q22020 wasn’t as disastrous for my real estate crowdfunding portfolio as anticipated. With only two hospitality investments out of the remaining 13, I was properly diversified enough to weather the worst of the storm.
Now, things are recovering. The strong performance of large IPOs such as DoorDash and Airbnb is proving there is a lot of pent-up demand.
Remember, hospitality is still largely shut down, but Airbnb’s shares increased by about 100% on its first day of trading! The company is now worth about $100 billion after raising capital in April 2020 at a valuation of only $18 billion.
Fearing public scrutiny and the negative implications of a pandemic made me overly conservative. In general, it’s better to be conservative than aggressive when it comes to financial forecasting. However, not by this magnitude.
I’ve always thought I wasn’t easily swayed by public opinion given my track record of telling the truth versus telling people what they want to hear. But this gross miscalculation of passive income definitely shows I am still affected by what others think.
Therefore, going forward, it is better to be more private about my passive income goals. With a new political ideology taking power in 2021 and beyond, it may be more important to go stealth than ever before.
You might be thinking: Why are you blaming yourself for your passive income miscalculation when the real estate crowdfunding distributions would have happened regardless?
The answer is that real estate crowdfunding is only one source of passive income. Further, passive income is only one source of total income.
As a Financial Samurai, you must create financial buffers for your financial buffers. Each financial buffer protects you from harm’s way.
A global pandemic is a clear example of a random exogenous event that could have obliterated your finances if you weren’t properly prepared.
Harm can only reach the final stage (you) after a series of unfortunate events. Even then, you still have a fighting chance to win against misfortune.
In addition to my passive income sources, I sometimes earn corporate consulting income, and I constantly earn active income from Financial Samurai. The occassional consulting income and active online income are considered my supplemental retirement income.
Every year, I sit down and work on my passive income forecasting. I estimate how much passive income I expect to earn and figure out how much supplemental retirement income is needed to fill the gap.
Earning supplemental retirement income is important for retirement longevity since interest rates have collapsed. Until this day, I still don’t know any early retiree who withdraws at 4% or who doesn’t early supplemental income.
Besides paying more in taxes than I needed to, the worst part of inaccurately forecasting my passive income is the time and mental health aspects.
Because my passive income estimate was much lower-than-expected, I spent more time generating supplemental retirement income to fill my perceived gap than necessary. The time I spent trying to generate supplemental retirement income could have better better spent with family or healthier activities.
There are worse things than making more money and having to pay more taxes than expected. However, it’s important to be more precise when it comes to financial planning. The government goes after income, not wealth.
Finally, with better passive income forecasting, you may feel less stress and anxiety. When the world is falling apart, the natural instinct is to cut costs and work harder. And that’s exactly what I did in 1H2020.
However, had my passive income estimates been more accurate, I would have been less stressed. At least I was thinking clearly enough to call the stock market bottom in March with a logical post.
The steps to improve your passive income forecasting should be pretty obvious. But sometimes things need to be spelled out as reminders.
The more regularly you can keep track of your passive income, the more accurate your forecast will be come the end of the year. Making an annual forecast at the beginning of the year and then seeing how things turned out a year later precludes you from making adjustments intra-year.
You must diligently add up all passive income streams by month and compare whether they are on track to meet your annual forecasts. You need to also add up all active income streams to come up with a total income.
Once that’s done, compare the total income to your desired income and adjust accordingly.
For rental income, the income streams should be relatively consistent each month. For stock and bond income, the income streams should at least be relatively consistent each quarter. But for private equity investments that have long investment periods, it’s vital to keep a record of when your initial investments were made.
For example, if you invested in a private equity fund in 2021 that says it plans to invest for 10 years, circle 2031 in your calendar. Better yet, give yourself a heads up starting in 2028 that you might start seeing distributions from your fund. This way, you can better plan your income streams for the next three years.
In my case, in 2017, I should have started creating monthly calendar reminders at the end of 2019 that distributions are likely coming in 2020.
Related: What Is Considered Passive Income? Analyze Stock Sales, Distributions, and Windfalls
You should create a conservative and realistic passive income estimate. Creating a blue sky estimate is nice, but it may do more harm than good. A blue sky estimate might lead you to undershoot on your passive income goals, which would reduce your chances of living your best life.
A conservative passive income estimate will help motivate you to generate supplemental active income. A realistic passive income estimate will help throttle your active income activity and better manage your tax liability.
The pandemic has made the majority of us feel worse due to heightened uncertainty. When stocks are getting crushed, your job is at risk, and you’re afraid of getting sick, it’s natural to feel more anxious.
If you are like me, you like to take action during a bad situation to try and make things better. Being able to take action is why I prefer real estate over stocks. However, this constant desire to take action can produce an unhealthy amount of stress and unhappiness.
The goal of passive income is to save you time from work and provide more financial peace of mind. Therefore, please do your best to accurately predict your passive income streams. Once you do, your life should get better.
Going forward, I will have two or three sets of passive income estimates to account for different scenarios. Further, I’m going to throttle my public passive income estimates to avoid unnecessary criticism.
Biden has said $400,000 is the income level deemed rich enough for higher taxes. Therefore, any household earning less than $400,000 should be acceptable by society. However, based on my observations, it seems like $300,000 is the household income limit before people start getting upset.
As a result, I’m going to keep my passive income goal below $400,000 if tax rates are going up. Anywhere between $250,000 – $350,000 is enough passive income to provide for a family of four in San Francisco or Honolulu.
It is also a large enough passive income figure where we can continuously save or reinvest 20%. However, if we have another kid, our passive income goal may increase again. I hope this will be OK if circumstances change.
For 2021, here is my latest estimated passive income streams by type. I’ve decreased online savings, stocks, and my severance negotiation book income. I’ve added a new rental income stream and I have increased my real estate crowdfunding passive income. I’m hoping this is a more accurate passive income forecast than last year.
If the economy continue to recover, there should be a natural increase in passive income as dividends, rents, ad business increase. However, I still plan to invest another $250,000+ a year to try and generate more passive income.
After stocks have risen so much, dividend-paying stocks are currently not my favorite passive income investments. Instead, I’m looking for laggards:
1) Physical rental property. Rents have softened in some areas as people have relocated or gotten off the fence to buy. However, the value of rental income has gone way up because interest rates have come way down. I foresee rents will stabilize and rebound over the next three years, bringing a double gain of capital appreciation and rent appreciation. As a result, I’m a buyer of SF rental property.
2) Real estate crowdfunding. The multi-decade trend of working from home and relocating to lower cost areas of the country is intact. Therefore, I continue to be an investor in the Midwest and South where valuations are cheaper and cap rates (net rental yields) are much higher.
My favorite platform is Fundrise, where you can own a diversified fund of real estate suited to your situation. For accredited investors, I like CrowdStreet because their DNA is investing in 18-hour cities (vs. 24-hour cities like SF/NYC) where there should be more job growth and better deals. Both platforms are free to sign up and explore.
3) Venture debt. After a tumultuous pandemic, venture debt is emerging to be more interesting because private companies want to shore up their balance sheets to fund operations. Venture debt funding also doesn’t dilute equity shareholders. Given its darkest before dawn, the last thing equity shareholders want to do is give up some of their ownership when times start getting really good.
Readers, have you ever inaccurately calculated your passive income to your detriment? What are some ways in which you accurately calculate your passive income? Have you ever felt pressure to earn less?
If there’s a car in your blind spot and you swerve suddenly, there’s a good chance you’ll get into an accident. Your accident will not only cost time and money to fix, you might also suffer an injury or even die. If you have financial blind spots, the consequences can be just as severe.
I can’t teach you how to be a better driver except to encourage you to slow down. But I can point out some financial blindspots to allow you to live a better life.
Here are five of the most common reoccurring misses that I’ve observed over and over again.
I’m not sure if homebuyers truly realize how much concentrated risk they are taking when they buy property. Most middle-class homeowners have a majority of their net worth in their primary residence. This can be dangerous during a downturn. Therefore, I want to use this post to discuss the main types of investment risk exposure to be aware of.
‘m particularly concerned about first time buyers putting less than 20% down because they can’t afford a larger downpayment. Given they can’t put at least 20% down, it’s likely they also don’t have any meaningful investments in stocks, bonds, or private ventures. In other words, they are all-in and then some with real estate. Always follow my 30/30/3 home buying rule.
Just in case it’s not obvious, mortgage debt is also considered investment risk exposure. You’re basically leveraging up to make a concentrated bet on a single asset that hopefully goes up. If it goes down and you need to sell, you’re screwed. During the last downturn in 2008-2009, the average American’s net worth got destroyed because over 80% of the average American’s net worth was in real estate.
Some people have asked why I wasn’t in a bigger rush to reinvest 100% of my house sale proceeds (~$1.8M) in this bull market. If I did, I’d still have $815,000 less in risk exposure because I paid off the mortgage.
The first reason why I wasn’t in a rush to reinvest the proceeds is because it was a lot of money. I don’t want to lose it. I redeployed about 60% over the first three months ad took another five months to redeploy the rest.
The second reason is because I needed firepower just in case I found a sweet property deal during the winter. I didn’t, but you just never know when opportunities show up. For example, during the height of the lockdowns in April 2020, I found a sweet ocean-view property in San Francisco for a $200,000 discount.
The final reason why I didn’t rush to reinvest is because I still had roughly $1,000,000 in mortgage debt. Meaning that with a current cash balance of ~$900,000, I’ve already got Maximum Exposure + $100,000 in leverage to risk assets.
Despite all that’s happened since I first wrote this post during the Obama administration, there are still many disadvantages of the Roth IRA in 2021 and beyond.
For years I’ve been an opponent of the Roth IRA. After the government came out with its tricky dick way to let us all do a “one-time” conversion from our traditional IRAs, I knew something was up.
The government was so successful in getting people to pay huge sums of taxes on their IRAs up front during the financial crisis that I just shook my head in disbelief. With so much stimulus spending to fight off the global pandemic, and I’m afraid the government will do the same thing. The government needs to find a way to raise taxes.
As a personal finance blogger who wants to help you achieve financial freedom sooner, rather than later, it’s my duty to write this post to help you see the error in contributing or converting to a Roth IRA if you have not maxed out your 401(k).
Of course if the choice is between NOT SAVING and saving via a Roth IRA for your future, then the answer is that one should open up a Roth IRA rather than piss their money away on stupid stuff that depreciates in value.
However, do know that you are still pissing money away by giving more of your money to the government. And if the choice is between choosing a traditional IRA over a Roth IRA, choosing the traditional IRA is hands down the way to go.
Please read all the disadvantages of the Roth IRA to keep an open mind. You can contribute to a Roth IRA if you are in the 24% federal marginal income tax bracket or lower. However, there are strong arguments as to be made why you shouldn’t contribute to a Roth IRA.
I really hope this article will wake you up to the tremendous government brainwashing that is being conducted to get you to part more with your hard earned money. If you’re still in favor, at least you know the other side of the story and Uncle Sam thanks you!
There are good times to retire early and then there are bad times to retire early. I’d like to highlight the worst times to retire early to prevent you from living a suboptimal life.
As someone who retired in 2012 and mentally un-retired by 2014, I feel it’s my duty to share all the landmines I’ve come across before you step into the minefield. Retirement isn’t all lollipops and roses.
To review some of my key findings, please read these posts before or after this post:
Not having to work is nice. However, if you retire at the wrong time, you will experience a lot of fear and doubt. These feelings will eat away at the pleasantry of early retirement. The uncertainty might get to the point where you wish you had never left a steady paycheck behind.
Ideally, you want to time retirement perfectly so that you get to do everything you want to do with your newfound free-time without having to worry about money.
