Category Archives: Pretirement How To

Pop your own housing bubble

Is it time to downsize?

It feels like a million years ago now, but the massive real estate crash of 2008 was only a few years ago. I saw the collapse up close and personal. Well before the crash, my wife and I bought a fairly large fixer, planning to move in once the bulk of the work was complete. Part-way through, we decided we hated the place and decided to complete the work and sell it. It’s what I call our inadvertent house flip.

Once we put it on the market, we had one (ONE!) interested buyer. No one else had really even given it a serious sniff. The housing market was cooling, but a total meltdown was yet to occur. But I could tell a bomb was about to go off. I just didn’t know how big the bomb was. My heart was racing nearly every day. Even as our buyers got squirrely, we did everything they asked, even suddenly replacing the furnace just days before closing. And we survived! With our asses intact. We didn’t lose any money but didn’t really make any either. All we lost in the end was a year of very hard work. We felt like winners as we watched the house’s Zillow rating drop by $200,000. That was late 2007. I think it was close to a year later that the stock market collapsed and all hell broke loose.

So that’s how I found myself sitting pretty when the big crash finally hit. I still owned a lot of real estate with rapidly declining value, but I had equity in everything and was cashflow-positive on the investment side. Plus I was working at a stable healthcare company. While the company was experiencing a brutal income drop as workers lost their insurance, it was getting through just fine. In fact, the crash may have helped that organization shake itself out of its complacency and begin running a much more lean operation.

Fear and debt

During that time, I talked to many of my coworkers about their finances. And they were SCARED. Scared shitless. One friend had decided to let the bank take his condo back after they announced massive assessments and he realized the value was never coming back. But most folks, many in their 40s and 50s, just had that blank stare of someone who is beyond panic. I had just two words of advice for them: Shed. Debt. These were good people, nurses and techs, who would wipe up your bodily fluids without thinking twice and give you a hug on your way out. Better people than I’ll ever be. They’d worked long, hard careers, but most of them had very little financial security.

That was when I realized just how much debt people were actually carrying. It was stressful for me just talking to them. Massive house payments, car payments, credit cards, school loans and on and on and on. I had just one good friend who was on track to having her house completely paid off and wasn’t even that worried after her husband was laid off. Good for her!

That’s not to imply that I wasn’t freaked out, though. I had three mortgages I was responsible for. Would have been four if I hadn’t unloaded that other home! I had to drop the rent price a few times and had a few periods of vacancies, but really it was not that big of a deal looking back. But, still, I was pretty spooked by the whole thing. That’s why I was so anxious to get mortgage-free as soon as possible and to reach financial independence as soon as possible.

Instead of reinvesting the cash from that home sale like we should have, (DAMNIT!) my wife and I decided to finally buy the house we really wanted, leaving my starter home behind. We also bought way too much house. Too much room, a nicer view than we really should justify given our financial goals and more yard than I can maintain.

That’s not to say we don’t love it. We love our neighbors. The house is wonderful. Our neighborhood cannot be beat. But it was probably well into 2010 before we realized how much this house is holding us back. So as we sit here in our beautiful cage contemplating our pretirement, we’re rethinking things. Hopefully many of you are as well. That fear that so many of us felt was driven by our over-inflated lifestyles. The good news is that we now have a chance to restructure things so we never feel that fear ever again.

Time to pop your own housing bubble?

It occurs to me that that the real estate market has largely recovered (at least here in Seattle), that it may be the right time for quite a few people to make strategic adjustments to their housing situations. Pop your own housing bubble, if you will.

Now on one hand, real estate appreciation could mean we’re in the perfect situation. Just ride up with the market, sell at the right time and be loaded! And that might be where we end up. Our neighborhood could very likely appreciate by 10% a year for the next few years. Don’t scoff, it’s true. Right now, houses are selling on their first day in my neighborhood and prices are rising rapidly.

On the other hand, depending on when a person purchased their home, they may already have significant equity but prices in general are still somewhat deflated, particularly if they were to move to another area. But more importantly, by downsizing, a family could move from being saddled with too much mortgage and back-breaking maintenance to a debt-free lifestyle with a fast-track plan to pretirement!

As always with real estate, whether this is possible for you depends on your situation.

Let’s say a family owes $400,000 on a house valued at $600,000 and are still paying on their original loan. They could dump the giant house, buy a still-very-nice $400,000 home and be paying on a mortgage of just $200,000. And with the low interest rates of today, they could enjoy an additional boost in their savings. And using my patented mortgage payoff acceleration plan, they could be mortgage-free in just a few years! Or they could rent awhile and put all of their equity toward their pretirement funds. That invested money could even generate enough income to pay a good chunk of their rent if they were so inclined. If the house can be rented to cover the mortgage or close to it, you could still pop your bubble by renting our your house and moving yourself to a cheaper place.

Can someone without a ton of equity also pop their housing bubble? Of course! Renting a fancy apartment way bigger than you need? Move! Only have a tiny bit of equity but know you bought too much house? Works for you too! You might want to wait a bit for the market to run up a bit more, but as soon as the timing looks right, sell it off and downsize!

The bottom line is that if you’re a normal American, you are living with way more than you NEED. By downsizing now, while you can, you may be able to greatly accelerate your pretirement. It’s time for a difficult conversation with yourself (and your spouse): How much do you REALLY love your house? I figure that by buying such a luxurious home cost us at least an extra TWO YEARS of working.

What will we do? I don’t know. We’re talking about it now. We’ll be here at least another year or so and then we’ll make the decision. We may rent a cheaper place for a time and pocket the difference (our current house could rent for quite a bit). We may even keep living here awhile. And, who knows, maybe we’ll change our minds and decide to take the hit and just live out our days here. It may be a cage, but it’s a damn nice one.

In the meantime, we’re getting this place ready to sell or rent. Even if we decide to stay here at least we’ll have all these projects done!

What about you? Are you thinking about popping your own housing bubble? 

Objective then Strategy then Tactics

howfeedtribeWhile it’s quite often that I’ll rip on the horribleness of corporate life, it’s important to acknowledge and learn from the good parts, too.

One of the most powerful things I learned during my career was how to do effective strategic planning. After many years in the trenches, I’m now very good at it and it’s become very natural for me to think strategically in nearly every aspect of my life.

If you’re thinking seriously about pursuing pretirement, or if you just simply have other financial goals (getting out of debt is a common one I hear about), approaching the problem strategically will make all the difference.

Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.
-Unknown (often falsely attributed to Sun Tzu)

The first thing we need to do is have a short primer on the difference between strategies and tactics. They are often mixed up and there can even be a little grey area between them at times. But, in general, strategy is about the plan. Tactics are about the actions. Strategy is about “how” while tactics are about “what”.

Strategy is buying a bottle of fine wine when you take a lady out for dinner. Tactics is getting her to drink it.
-Frank Muir

When undergoing strategic planning, by far the most important thing is to ensure the tactics line up under the strategy, which in turn fits under the objective. If the tactic does not meet the objective and falls outside the strategy it MUST be rejected (or the Objective or Strategy must be modified). Many, and maybe even most, companies do not maintain strict discipline on this and end up wasting resources, doing duplicate work and creating a disorganized, unfocused organization. This in turns ruins morale and makes everyone hate their jobs.

This can happen in your home life, too. We’ve all seen families that aren’t on the same page financially, don’t have a clear direction and often the married couple are at odds. It seems to them, and everyone else, that they are just “bad with money” or are “fighting about money”, but in reality they have no clear objective or shared strategy. Their tactics, then, are just a collection of haphazard, uncontrolled actions, usually buying stuff they can’t really afford with the vague idea that they’ll pay the credit cards off later “when we get some money”.

In a way, it’s understandable. We didn’t evolve to analyze things in this way. Early man wasn’t putting together a PowerPoint document on the best way to feed their tribe (“Objective: Feed tribe. Strategy: Find and kill mammoth. Tactics: Use spears to stab mammoth.”)  No, we evolved to use our instincts to figure out these challenges. The food captured was the easiest and safest food to get that would provide adequate nutrition. This led to farming and eventually society. Unfortunately in a modern world, especially one with cheap and easy credit, these instincts for the quick and easy fix lead directly to mindless purchasing. Not to mention our evolved interest in anything shiny (probably evolved to help us find fruit, fire and water), tricks us into wanting the fresh and new.

But we also evolved a brain that is able to think abstractly and can overcome these predispositions with logic, education and mindfulness. And that’s why it’s so important to use strategic thinking to our benefit. The hardest part, of course, is then resisting these urges to help us reach our goal.

Let’s say a family is $20,000 in credit card debt and is feeling depressed and hopeless. Our imaginary family might want to cheer themselves up by taking the kids to Disneyland. After all, it’s a relatively cheap trip and they’ve been promising the kids the trip for some time now.

If their Objective was “relieve temporary depression” and the strategy was “spend a little money on something fun” then the tactic might correctly be “take a trip to Disneyland”. See how identifying the correct Objective can help you build the right strategy? If they had identified their Objective as “Get out of debt as soon as possible”, there is no way they could end up with a tactic of taking this trip. Their strategy would be something like “cut all spending to the bare minimum, try to increase our income and put all additional cash toward the credit cards”. Tactics might be things like cutting out cable TV, taking on some side work, etc.

Sometimes you can reverse-engineer this approach to figure out what someone’s real objective is, which can be pretty interesting. Take for example, organized religion. While I am a confirmed atheist  I’m not here to question anyone’s faith. And I draw a bright line between faith (which I politely respect) and organized religion (that I despise). But, that aside, organized religion makes a really clear example. See, for example, religions that oppose birth control. Why would they do that? Let’s reverse-engineer it. Take Mormons, for example, who at one point famously even allowed multiple wives and even today oppose birth control. Yep, now one of the fastest growing religions. Add in their tactic of sending young people on missions around the world, and it’s clear what their objective is — massive growth.

OK, now that I’ve offended half my readers, let’s talk pretirement. If pretirement (investments cover expenses) is the Objective, then the strategy is likely one of lowering monthly expenses and building up the pretirement fund. From there, it’s all tactics. Where and how to save, what to invest in, how to increase income, and so on. Having a shared Objective with your mate and agreeing on the Strategy is one of the keys to a long and happy relationship and life. And we’re not just talking about money.

What are your Objectives, Strategies and Tactics for reaching Pretirement? 

Caveman image courtesy FreeDigitalPhotos.net

What’s your minimum monthly requirement?

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Mea Culpa! 

This piece was originally published on Tuesday morning. In a rush to publish before I headed up to beautiful Vancouver, BC for a mid-week getaway, I inadvertently posted what amounted to a very rough draft. I wrote the piece in the middle of the night the day before we left town, planning to go over it in detail in the morning, include correct numbers from my assumption spreadsheet and then head out of town. Well, of course, I failed to do that. Thank you to those of you who wrote pointing out my errors and thanks to those of you who politely overlooked the errors and took away the overall point. I took the unprecedented step of taking this down until I could get home to my computer and carefully correct things. Publishing this before it was ready was not fair to you, my readers, and it won’t happen again. Thanks for understanding! 

I’ve never really tried to live within a budget. That has probably been a mistake.

Budgets can be powerful and great for setting yourself on a path to financial success. But I usually had enough money for whatever I needed. And if I didn’t, I typically would just wait. And being somewhat frugal by nature, I never really needed to restrict myself to a given number.

However what I have done is keep close track of what really is going OUT the door. (Which is different than setting budget goals and restricting myself to them.) This sometimes depressing look at my finances helps me rein in runaway bills and think about new ways to drive costs down.

Keeping close track of your actual spending is particularly critical if you’re pursuing pretirement. If we view pretirement as the point when our passive income becomes large enough to cover our monthly bills, knowing that number becomes all-important. And, even more importantly, the lower we can get this number to go, the sooner we can be free.

Take two hypothetical couples: (as I often do, let’s assume both have no housing costs and both have the same income for this example)

  • Couple 1: Monthly bills = $3,000 (a couple car payments, high utilities and commuting costs, cable TV, expensive vacations and some spending money)
  • Couple 2: Monthly bills = $1,800 (relatively frugal living but still a nice middle-class lifestyle)

Couple 1 would need a fund of more than $1 million to support their lifestyle. Couple 2 will need around $600,000 for theirs. Worse, Couple 1 probably can’t even build up enough to pretire because most of their income is likely being spent. But if we assume both couples can save a nice, round $1,000/month or $12,000/year (remember, this is pretirement, not “retirement”), the differences are vast.

Our frugal couple that only needs to reach $600,000 would be pretired in 25 years from the point when they started building their pretirement fund. Our spendy couple, Couple 1, would need to work 10 extra years beyond that to reach their $1 million goal. (I’m assuming a reasonable 5% taxable yield from their pretirement funds in both cases.)

But more realistically, because Couple 2 is frugal, they should be able to build their fund much more quickly. Let’s say the $1,200 difference between the two couples is put into the pretirement fund. Both are still saving the original $1,000/month. So Couple 1 is just saving $1,000/month and Couple 2 is building their pretirement fund with $2,200 each month. Couple 2 will now reach pretirement in around 15 years.

For our spendy couple, that’s an additional 18 YEARS OF WORKING!

Hold on a second while I add some additional exclamation points to ensure this point gets across:
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

So since none of us want to be forced to work an extra 18 years or more, let’s agree that driving down ongoing monthly expenses is critical to reaching your pretirement goals. But how low can we get that monthly nut to go?

This is where every person or couple is different. Our expenses may differ from person-to-person and even during various stages of life, and especially in different regions geographically. But we can agree that there are some common spending leaks that should be eliminated immediately. And if we eliminate the mindless spending from our monthly outgo, how much is left that HAS to be paid?

In discussing this topic recently with a few friends and in reading some other blogs, nearly every household said the same thing: the monthly “core” bills total to around $2,000/month. Some a little less, some a little more, but every time it comes up, it’s around $2,000. Isn’t that odd?

I was rather shocked there was so little variance so I went back and double-checked my own numbers. Here are my core monthly expenses:

  • Groceries/Eating out: $350
  • Utilities (water/sewer/garbage) $101
  • Electricity: $78
  • Gas (heating and stove): $66
  • Internet and TV: $63
  • Cell phones: $129
  • Car insurance: $256
  • Life insurance: $88
  • Property tax house: $440
  • Homeowners insurance house: $46
  • TOTAL: $1,618

I’m not counting a few things here, which is a little misleading. Any social spending is not included, such as going out to breakfast with a friend, like I did last week. Also certain expenses and random spending money aren’t included like haircuts, my wife’s commuting costs (I don’t have an office I have to go to, except down the hall), or our small splurge at the Farmer’s Market on Sunday. So maybe we average around $1,800 or so most months. Like I said, “around” $2,000/month. But can we drive it even farther down?

The $1,600 above corresponds roughly to our current “pretirement” goal (or $800 for my both my wife and I). Now, obviously(?), we’re not going to stop building our pretirement fund once those levels are reached. Rather, it’s a difference in mindset. We want to know we’re free. And in this case, we’re just talking about the minimum. We know we’ll need a little more safety cushion and we haven’t even talked about inflation and costs related to raising our son. And, because this is lunatic America, we have to think about health insurance (but not today since my wife is still working full-time).

So how low can we get our monthly bills if we really pushed it? Without moving from our home, we feel we can get down to $1,500 for our basic bills. That’s dropping the fancy cell phone plan (already underway) and lowering our car insurance (we have three vehicles currently — long story) and using our utilities more efficiently. But the much larger savings come if we downsize to a smaller home and can pay less property tax. Or if we were to move and rent, we’d probably be cashflow-positive so we could potentially be even a couple hundred lower.

But even with those savings, and knowing we’d want to have some spending and cushion money, our realistic minimum monthly requirement is still “around” the magical $2,000. Once we hit our goal of bringing in a passive $1,600/month, we’ll declare ourselves “pretired” but we’ll keep building at least until we have a solid $2,000 rolling in.

I’d be very interested to know if readers are finding themselves close to the same number. Are you over or above $2,000/month? What is your minimum monthly requirement?

Image courtesy of Stuart Miles / FreeDigitalPhotos.net

Should you pay off your mortgage?

It’s your biggest bill — is there any reason to keep it?

If you’re reading this from the U.S. or Canada and own a home, chances are you have a mortgage. And if you have a mortgage, you’ve no doubt wondered from time-to-time if it is possible to pay it off early. As I previously showed in How to get rid of your mortgage, it is.

But today I’d like to discuss whether you SHOULD pay off your mortgage.  

There are two distinct camps in this discussion.

One one side, there’s the “peace of mind” camp. These guys advocate for getting rid of this debt as soon as possible to remove stress from their family. These folks tend to be naturally opposed to debt in the first place and taking on a mortgage in the first place was only an act of necessity. You can read more about this point of view here.

In the other camp are the investors. The investors can’t bear to have even a single dollar making less than its maximum potential. These guys look at today’s low interest rates, realize they can do better in the market and feel they are losing money by putting their money where the interest rate is so low. You can read a good writeup on this perspective here.

And, like any good disagreement, there are those that fall in-between, which is where I land, although I definitely lean toward the “peace of mind” peeps.

But let’s take a deeper look.

The investors often mention a 5% yield on investments as being a reasonable goal in today’s market. You might want to shoot for more if you’re particularly aggressive or young but you might want to aim for 3-4% if you’re older and/or need to be more conservative. But for purposes of discussion, we’ll use 5% as a good target.

So if you can earn 5%, does it make sense to target your funds at a rate of less than 4%? As of this morning, you can get a loan (theoretically) for 3.5%. Nice, right? An extra margin of 1.5% going to YOU!

Let’s pause, though, to recall what an interest rate represents. If you remember your basic economics, an interest rate is just the market representation of risk. If you’re a less risky borrower, you’ll get a cheaper rate when you buy your house. Same on the investing side, you can find investments that earn 10% or more, but your money is increasingly at risk the higher up you go.

So when thought of in that way, we should look at paying off our mortgage as “earning” the rate of our home’s interest rate. Or, in other words, we can earn a relatively safe 3.5%. I also like thinking of the principal of your home as “savings” and the interest you pay as the “cost”.

Good reasons to consider NOT paying off a mortgage

  • Your employment is secure for the long-term
    It’s easy to forget how massive the bloodbath of 2008 was. Many (many!) people who never even considered they’d be out of work were suddenly faced with bills they couldn’t pay. But if you believe you’re completely safe from job risk  or have other “safe” income sources, you could stay leveraged.
  • You have adequate safety measures in place
    Because no one knows what will happen, you have to be ready for anything. A year of your monthly expenses kept in relatively safe, accessible investments should be adequate to keep you out of trouble.
  • You are relatively young
    I’m not a fan of people in their 40s and 50s staying highly leveraged just to squeeze a bit more out of their investments. For younger people, they are  in a better position to withstand a downturn.
  • Family situation
    If you have kids, you might be more focused on increasing your security more than in building up your investment fund.
  • You have a high risk tolerance
    Being willing to lose large sums of money comes with the territory if you’re choosing investing over removing debt.
  • You are highly disciplined
    Most people who say they’re staying leveraged for investment reasons inadvertently end up loosening up their cashflow and spending rises, leaking their funds out to the consumerist world.
  • Inflation
    Should we run into a hyperinflationary period as many believe we will, your “locked-in” payment amount will be trivial compared to your newly “inflated” income.

Good reasons to consider paying off a mortgage

  • You’re in your 40s or 50s
    If you’re working toward pretirement and can see traditional retirement looming on the horizon already, you should be grateful we’re in a low interest rate environment. In times past you’d be stuck swallowing massive amounts of interest as you worked to tame your mortgage. (It’d be even more important to do so in a higher interest world, however.) With low interest rates, though, you can much more rapidly work this debt down and thus lower your needed investment number to reach pretirement.
  • You can’t stand having debt
    We often overlook emotional needs when talking finances. But we’re living our lives here. If it stresses you out to carry debt, by all means get rid of it!
  • You couldn’t handle large investment losses
    Beyond emotional reasons, a massive investment loss could devastate some people. You can build a safety wall against big losses by removing debt instead of playing the market.
  • Your balance is small
    If you have a relatively small amount left to pay on your mortgage, it might be worth getting rid of that annoyance as soon as possible.
  • Your job is shaky
    If you think your job could be at risk, living mortgage-free will greatly increase your safety margin.
  • A paid-off mortgage can act as a safety fund
    When a mortgage is paid off, it’s trivial to get a line of credit for emergencies. Hopefully you’ll never need it, but it’s great to have a large fund available. This allows you to keep the rest of your money invested as aggressively as possible.

Now I don’t advocate paying small additional amounts to principle over the years. This strategy is actually designed for people that don’t know how to manage their money, locking it away from them so they don’t piss it away. I recommend saving and investing outside of your mortgage for eventual pay-off or refinance. That means keeping this money semi-liquid and trying to earn more with that money over the years.

One could also consider a hybrid strategy: Pay off the majority of your loan and invest a smaller, controlled amount, say, $50,000 or $100,000. It lowers your risk but also lets you gain additional earning from a decent chunk of money. That may be just enough peace of mind to make it worth your while.

When we talk pretirement, however, the goal is to bring financial freedom within reach as quickly as possible. This is why I lean toward the Pay Off camp. By lowering your overhead, you have a clear target for monthly income and can even rely on part-time work to cover those bills. It’s typically one’s mortgage that keeps one working full-time. Look at your own bills and let me know in the comments if that is not true for you.

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