Should You Pay Off Your Mortgage Early or Invest?

Scott:
Welcome to the BiggerPockets Money Podcast, show number 272, Finance Friday Edition, where we interview Javier and talk about where to direct your investing focus.

Javier:
So that leaves me with 1,300 leftover. And I’m just trying to understand what would be the best place for me to put that if I wanted to retire, or not even retire, just be financially free in let’s say 15 years or something like that.

Scott:
Hello. Hello. Hello. My name is Scott Trench and with me as always is my sunshine in her pocket co-host, Mindy Jensen.

Mindy:
What a glowing introduction, Scott.

Scott:
Yes, Mindy and I are here to make financial independence less scary, less just for somebody else, to introduce you to every money story, because we truly believe that financial freedom is attainable for everyone, no matter when or where you’re starting.

Mindy:
Why does this switcheroo make me so giggly?

Scott:
I don’t know, but it’s your section now.

Mindy:
Whether you want to retire early and travel the world, go on to make big time investments in assets like real estate, or start your own business, we’ll help you reach your financial goals and get money out of the way so you can launch yourself towards your dreams.

Scott:
Mindy, I am so excited to talk to Javier today here. I think he’s got a phenomenal background and story. I think Javier’s a big follower of Dave Ramsey. And what I think we unpacked is that if you are going to follow the baby steps of Dave Ramsey and you’re going to be completely debt-averse, pay off the mortgage first before really committing heavily to other types of investments, build out that year long emergency reserve, follow those steps, I think it changes the math on how other types of investments may make sense or be prioritized.
For example, maybe it makes more sense to become an entrepreneur earlier, if you have such a strong financial base and make a median upper middle class income with that. Maybe that’s a path to explore more heavily than someone who’s investing in real estate and earning a much higher income and trying to get the maximum returns on each dollar of cashflow invested. And so I think that that was an interesting discussion and potentially a new framework to put into some folks’ minds and put a bug in their ear.

Mindy:
Yeah, I really like the different opportunities that he has available. And because he has kept his debt nonexistent, he has no debt other than his mortgage, because he has a handle on his expenses, because he is spending less than he earns, he has a lot more options than somebody who has a lot of debt, credit card debt, student loan debt, whatever kind of debt they have. Somebody who is in a different financial position doesn’t have as many options as he does.
Another thing, after we stopped recording, we talked to him about finding what his bare bones numbers are and that is something that I would suggest anybody listening do. If you are looking for your emergency reserve fund, what is your bare bones amount of money that you need to live your life, your mortgage, your utilities, your food budget. If you’re cutting out restaurants, you’ll need a little bit more in groceries, but not as much as if you were going to restaurants as well. There’s a whole lot of things involved in this. But finding out what your bare bones budget needs to be is really enlightening for all the opportunities that it opens up once you know your numbers.

Scott:
Yeah, absolutely. I think that that’s critical into figuring out how much emergency reserve you really need and being really comfortable with that. And there’s a huge psychological impact to that in terms of your tolerance for risk and those types of things.

Mindy:
Yeah.

Scott:
All right, Mindy, before we bring in Javier, our attorney makes me say, the contents of this podcast are informational in nature and are not legal or tax advice, and neither Mindy nor I, nor BiggerPockets is engaged in the provision of legal tax or any other advice. You should seek your own advice from professional advisors, including lawyers and accountants regarding the legal, tax and financial implications of any financial decision you contemplate.

Mindy:
Javier is in a medium cost of living area and has a pretty good handle on his expenses. He’s looking for some guidance for where to direct his income once he pays his house off next year. Javier, welcome to the BiggerPockets Money Podcast.

Javier:
Hey, Mindy and Scott. Great to see you guys.

Mindy:
I am so excited to talk to you, because I think you have an interesting set of circumstances. So let’s jump right into it. What is your income and where’s it going?

Javier:
Awesome. All right, so I make about a little over 5,000 from my W-2 job and my wife makes 2,000, maybe 2,200 a month. She is a mental health therapist, she’s a contractor. So that is her job. I also do real estate on the side as well. I didn’t include that because it’s very variable. I mean, last year was awesome for me, but it depends on how busy my job is.

Scott:
Last year being 2021?

Javier:
Yeah. I’m going to say, yeah. We’re almost done, so. And then where is it going? So mortgage, I have it at 1,730. Charity, so we do tithes for our church, so it’s about $1,000. And then for taxes, we have 675 for taxes. Daycare, we have 500.

Mindy:
Hold on. Let’s talk about those taxes, because 675 is a lot in taxes. What kind of taxes are these?

Javier:
Yes. So we are saving up 30% on whatever my wife’s income is. And then if anything comes in for real estate, I do the same thing there. So I’m just making sure that when that tax bill comes later, I’ve got a little fund saved up for paying that off.

Mindy:
Oh, so that’s your income tax that you’re saving?

Javier:
Correct.

Mindy:
That’s not property taxes or something? Okay. Okay. I like 675 income tax, I don’t like 675 property tax at all, monthly. Okay., I’m going to stop you right there and say, I think that’s really, really intelligent that you’re saving in advance for your property taxes because Uncle Sam is not going to wait in line. He is going to stand there with his hand out first. So I like that a lot. Okay, sorry for interrupting. Continue please.

Javier:
No, you’re good. You’re good. So 500 for daycare. 350 for utilities. 300, for restaurants. 215 for gas and 200 for car insurance. We’ve got 200 for fun money, so that’s an account that my wife has that I can’t say anything about so she can spend it on whatever she wants. I’ve got 150 for the doc and 150 for television and internet, and 1,000 for groceries.
And then we’ve got some things we prepare for. 50 for gifts and 50 for vacation. So usually that’s for Christmas, or if we do a year trip, that’ll be the funds that we use. 50 for clothing. 50 for phone. 50 for personal care, things like haircuts and things like that. 20 for work expense and 25 for gym. So I make about 7,200 coming in and then expenses are about 6,800, so we usually have about 400 left over. Plus some of these accounts, we don’t use everything up, so that can be rolled over into that savings as well.

Scott:
Where is your net worth? Where’s that going? Where’s the cash going and what have you built?

Javier:
Yes. So we have our house at 400K right now and we owe 65K on that, and that’s at a 3.75% for our mortgage. I’ve got 160K in a 401k, which I just rolled over into an IRA. So I’m kind of starting fresh at my new job with a new 401k. I’ve got 23K in emergency fund, and then 17K in an aftermarket brokerage account. So net worth I think is around 530, 540 area.

Scott:
Awesome. When you say that you’re paying 1,730 in mortgage on that one, what is that? Where is that going? Is that a lot of excess payment going towards that mortgage?

Javier:
No. So we put it on a 15 year loan, so that’s everything, principal, interest, taxes, insurance.

Scott:
Okay, awesome. And you have 65,000 left? How much was the original balance on that mortgage?

Javier:
180,000.

Scott:
Okay, so you’ve paid 120,000, 115,000 of that balance so far. And how long have you had that mortgage?

Javier:
In March will be our third year.

Scott:
So Javier, I’m noticing it looks like you’re intentionally paying off this mortgage very quickly. And something that stands out to me about your financial position is that you just said, hey, we’re bringing in 7,200 a month and then we’re spending 6,800, which leaves us a $400 surplus, yet we’ve got a $100,000 in mortgage paydown and a $500,000 net worth. So it tells me that I’m either getting a really conservative understanding of your financial position from you or there’s some other factors at play here with that. So I got a two part question. Why are you paying down the mortgage? And then is there anything else that I’m missing about your overall financial position that I should understand?

Javier:
Yeah, so answer to question number one is I’m very risk-adverse, so I’m trying to have as little debt as possible. From a personal standpoint, I’m a very big component of Dave Ramsey, so having as little debt as possible. I understand for businesses, for leverage it doesn’t really make that much sense, but from a personal standpoint, it always resonated with me to have that no debt in my life.
And for the second part, for me to be able to pay down as much as I have, I am a part-time real estate agent, so any funds that I get from being a real estate agent goes straight into paying down the house. Again, I also do the 30%. It’s actually 40% total, because I do 10% for tithes for church, 30% for taxes, and then any remaining goes straight to paying off the mortgage.

Scott:
Wonderful. So what is the level of income that you achieved from your real estate activities in 2021?

Javier:
So gross in 2021 was 60,000.

Scott:
Okay. So we’re having essentially another income coming in that you’re just saying, hey, my financial picture, I’m not planning on that, but every time I do get those dollars and they’re very real and very large, I’m plowing that into the mortgage?

Javier:
I will say though, the year before that, in 2020, it was only 5,000, so that is why I’m not banking on it. It just was, I don’t know, COVID year was a really good year for real estate, and so I just took advantage of that and applied everything to the mortgage.

Scott:
Awesome. Well, would you mind also giving us another three minute overview of your money journey because there’s another $500,000 in wealth here to account for in addition to this side income of 65,000 from the agent activities.

Javier:
Gotcha. Okay, so I come from first generation and second generation immigrant parents, so it’s all about frugality. I’m not splurging on a lot of things, and preparing for the future. I think when they came over and built up their life, they were always talking about getting a better their life for us, so I always had a financial understanding going into my first career. So my first job at 21, I was starting a 401k and building that up. So since I was 21, I’ve been putting 15% away of my income since then. I do it today.
And the house, it has to do with the market. So our first house we sold for a 40K profit. We rolled that over into our next house. And then it’s gone up in the past year and a half, about 110K. So that was a huge jump in our net worth. So it wasn’t really anything that I was doing, it was more benefiting from the market that we’re in.

Scott:
How can we help you today? What are some of the goals that you’d like us to think through or work with you on?

Javier:
So my biggest question right now is in a year when I pay off my mortgage, I’m going to have $1,300 left over. So I’m going to be saving 500 for escrow, so for property taxes and insurance. So that leaves me with 1,300 leftover. And I’m just trying to understand what would be the best place for me to put that if I wanted to retire, or not even retire, just be financially free in let’s say 15 years or something like that, because I’m not very career oriented, if that makes sense. I’m not trying to be the CEO of a company. I’m more trying to do something that I love and use those funds for things outside of work, if I want to go travel or something like that. So I just want to make sure that I’m putting that money in a place that’s going to be there when I need it later down the line.
And also, sorry to interrupt, I want to make sure that if I do retire at 50, if I decide I want to be out, I want to make sure I have the income that’s going to sustain me until 65 and my 401k kicks in, if there’s a smart way to do that.

Mindy:
Okay. I think, first of all, don’t be sorry to interrupt. This is your show, ask away.

Javier:
Awesome.

Mindy:
Second, do you know your FI number? Do you know, based on the 4% rule, which I am assuming that you’re familiar with, have you figured out how much money you’ll need in retirement?

Javier:
If I retire at 50, it’s like 2.2 million that I need.

Mindy:
Okay. Starting at age 50? So I’m going to do really quick rule of 72 numbers. The rule of 72 says that essentially your money will double approximately every seven and a half to eight years. I’m going by eight, because I already did the math before we started the show.
So your 401k, assuming a 10% return, which is a nice conservative return, past performance is not indicative of future gains, I can’t guarantee you this, but at age 32 you have 160,000. At age 40, you will have 320,000, because it doubled in eight years. At age 48, it’ll be 640,000. At age 56, it’ll be 1.28 million. And at age 64, it’ll be 2.56 million, assuming a 10% return and assuming that you don’t put another dime into it. This is your pretax 401k.
I think it would be very interesting to look into your Roth options and max those out because you’re so young, and because I keep coming back to Kyle Mast’s episode, 200, where he said, he really feels that the Roth could be on the chopping block. It passed this last year. The backdoor Roth thing they didn’t get rid of. But he said the government essentially has been writing a lot of checks over the course of the pandemic, which is a true statement, they have. Somebody has to pay for those.
So where is that money going to come in? You need to look for ways to easily generate income for the government and taking away the Roth option could be a really easy way, leave what’s there and then going forward, it doesn’t exist anymore. Of course this is not guaranteed. We have to wait for the government to make up their mind, but that’s an option that I would like to see you pursue for as long as it’s available to you.

Javier:
So I should have mentioned this, my 401k is a Roth. I will say though, half of it is from my prior company. So 80,000 of it is employer funds that they provided and the other income is from me that I’ve put in there.

Scott:
Awesome. So I’m hearing the goal is 15 years to financial freedom and $400 a month is not going to cut it, but 2,000 might when you cut out your mortgage payment with that, and adding on another 5,000 per month in real estate sales commission income won’t hurt on that journey obviously either. Let me ask you this, what is your day job again and how much time does the real estate side hustle take?

Javier:
So my day job right now is I’m a learning and development manager. So I work on training our employees and filling any gaps they have in knowledge with content that we can create.
So real estate, it really depends on who I’m working with. So right now I work with two investors and they are able to keep that deal flow going because I’m on the buy side and on the sale side with them. And so they’re my main providers as far as income with my real estate. So it honestly depends on how they’re doing and they’ve been doing really good this past year, so I’m hoping that trend happens. And then anytime I get a retail deal within there, then that’s just an extra bonus option there. So I’m hoping I can have a repeat year, but I just don’t want to bank on that happening every year.

Scott:
And I also want to observe that you have 23,000 in emergency reserve, which is how many months of spending for you?

Javier:
That’s about four to five.

Scott:
Four to five months? Okay. I think that there’s an investing approach, but there’s also another angle to think through here in your finance journey, which is you have a very risk-averse situation in terms of you’re paying off all your debt and you have a nice emergency reserve, and you’ve got a very strong financial foundation with all of this. That to me suggests that you’re in really good shape for an entrepreneurial venture of some sort at some point in time, because you do have one spouse providing income, an emergency reserve, and this side hustle that seems to be picking up with that.
And so that would be one of the bugs I’d want to put it in your ear, before we talk about the investing side of things is I think that opportunity in the real estate world is probably not consuming anywhere close to full time effort for you and you’re earning a much higher dollar per hour on your time doing that activity than it sounds like you are from your full time job with that. And it has almost surpassed your income and it may be able to dramatically surpass your current income within a couple of years.
By paying off the mortgage and having a really strong emergency reserve in classic Dave Ramsey fashion that may set you up to go after this opportunity and funding that may be a much higher ROI than beginning to more aggressively repurpose those dollars for index fund investments or something like that. What’s your reaction to that thought?

Javier:
So two reactions to that. One, I actually do own a brokerage company with a partner. The reason I didn’t include it is because we’re not profitable. We’re pretty much breakeven at this point. We’re trying to get more agents under us so that we can start to turn to that black number. So I do have that brokerage. It’s not growing at the rate that we wanted, and so that’s why I didn’t count it. So that is my opportunity to be an entrepreneur.
But my other thing is being risk-adverse my biggest fear right now is healthcare insurance. So being out there on my own as a contractor, or not having that employer medical benefit, I mean, seeing the cost that it is to be on your own is a little daunting. So I don’t know if you guys have an answer to help with that, to ease my stress in that area, but that’s where I’m holding onto these W-2 jobs. Because there might be an opportunity if I go all in, on real estate, that it could surpass what I’m making now, but is it at a bigger cost of the health insurance cost that I’m going to take?

Scott:
I think that’s a great concern and that that is an unsolved problem in the financial independence and I think contractor or self-employment or entrepreneurial space right now is that insurance is going to be expensive and it is a benefit you’ll lose. And that is another $20,000 in income that you have to generate for this type of work to over-

Javier:
At least.

Scott:
Yeah. To benefit you in excess of that benefit you may be getting from your employer, depending on how much of a percentage of the healthcare plan your employer contributes. So I think it’s a great call out, but it’s something to ask yourself is, great, I need to earn another $20,000, how many more commissions do I have to earn in order to cover that cost? Mindy says one. She’s in Colorado. He’s in a suburb of Atlanta, so I don’t think that that is quite as-

Mindy:
How much are houses there?

Javier:
So the average houses that I’m working with are around 250,000, 300,000.

Mindy:
Okay, so that’s two commissions.

Scott:
That’s more than one commission.

Mindy:
Yes.

Javier:
Yes.

Scott:
Maybe four.

Mindy:
So that’s two or three, because you’re thinking about paying your taxes. Let’s call it three commissions. How can you generate three more real estate retail sales a year? Are you pitching to list houses? Are you pitching to buyers to represent them. Hey Scott, do you know any place that he can find more clients?

Javier:
So I would have to go a lot more serious on marketing. I’ve made it a side hustle, so I’m not pushing it as hard as if I decided that this is my full time job. I would have to invest a lot more time, a lot more effort into that. I think I could increase it, but I would just have to put the effort into making that happen.

Mindy:
Okay. I just heard you say, I would have to put more effort in, I would have to treat this more as a business, I treat it as a side hustle. Are you telling every single person you know that you’re a real estate agent?

Javier:
Not every person that I know, no. Or if I am doing it, it’s more sheepishly, if that makes sense.

Mindy:
I think that you should be proud to be a real estate agent and make sure that everybody knows, make sure that your wife is telling everybody that you know, “Javier is a real estate agent. If you know anybody who’s looking to buy or sell, he would love to help you out. He works in this area.”

Scott:
I’m also going to chime in here and do a plug for something we’re working on here. We have a network of investor friendly agents on BiggerPockets under the find an agent tab. And I’m going to, after the call, hook you up with how to get started in that, since you already work with investors on that, so that you could test out what it would be like to begin working with a lead source from investors who want to work with investor friendly agents like yourself on that. So that’s something to check out if you’re an agent and listening, or if you’re an investor and you need an investor friendly agent. But let’s chat about that after the show here as well.

Mindy:
Another thing that I am going to do is send you a copy of the book by David Greene called SOLD. And it is about … I need to get a stack of these book.

Scott:
We got two hard plugs today. This is great.

Mindy:
Yes. Oh, here it is. Here it is. What I really need to do is organize my office. It’s SOLD: Every Real Estate Agent’s Guide to Building a Profitable Business. So I’m going to send you a copy of this book so you can start reading this. This is David Greene, the host of the Real Estate Podcast. What does he sell, 80 billion houses a year? He knows what he’s talking about. And if you read this book and you don’t increase your agent business, it’s because you didn’t take any action, you read the book and you were like, “Eh.”
And you won’t say that because David is really, really good at hyping stuff up, and it’s not hype. That sounds terrible. It’s not hype, it’s all solid information, it just happens to be he’s going to get you excited about doing it too. So I’m going to send you a copy of that book, which you should absolutely read because David Greene’s amazing.

Scott:
Yeah. We always talk about these four levers, spend less, earn more, invest, or create. And what I’m seeing from your position, the way you’re wired is you want to give a lot, you want to not have any debt, you manage your finances extremely conservatively. And so to me, that screams, okay, great, once you’ve done that, create, start a business with that. And you can choose when to move into that path, it doesn’t have to be, oh, you’re going to start this tomorrow. You can keep your side hustle going for the next year or so.
But my instinct in your situation is to say, okay, great, pay off the house, round out that emergency reserve to six months or a year, sit really pretty and comfortable with that. And as you are progressing towards that state where your mortgage is paid off and you’ve got this hefty emergency reserve, figure out what you’re going to do about the healthcare.
Well, if you start a business, it’s a business expense, so that reduces some of that hurdle to clear $20,000 in health insurance costs. Can your wife change from her contract role to something that might be able to provide healthcare for the family? That’s something that over the course of a year or two, an opportunity there may materialize. And that would give you a really, I think, convincing position to begin thinking about, okay, I’m going to wind down here and go after the opportunity over here. That’s my instinct. How does that feel? Does that seem like-

Javier:
Yeah. I mean, I do like that. It gets me away from the W-2 job and more into fending for myself, which eventually I want to be able to do. I mean, based on what Mindy told me, I didn’t realize that if I didn’t do anything else on my 401k, that I would essentially coast FI to the number that I had thought of at 65. And so what I could do is more focus on the entrepreneurial side that I can do during this time, since I don’t really have major expenses holding me back.
So next year I’ll pay off my mortgage. I don’t have any car payments. I don’t have any credit card debt. I don’t have any student loans. And so it’s really just making enough to pay for my general expenses, and then just focusing on that. I think it’s something that I’ve been saying I’m going to do, but I haven’t actually done it. I’ve got little ones. I’ve got a five year old and a going to be three year old, and so I was trying to focus on them. But they’re starting to get to that school age where they’re no longer my excuse anymore. And so I need to dive a little bit deeper in making an effort into growing my real estate business.

Mindy:
Yeah, and growing it while you have a job. While you have the solid W-2 income is really the best way to grow that side hustle, that second job, that entrepreneurial endeavor, because it’s okay if you fail. And real estate, I’m seeing conflicting reports, that the market is going to more even out next year, and I’m seeing reports of, nope, it’s going to be hotter than ever. I tend to believe that it’s going to be hotter than ever simply because inventory isn’t there yet. But all the people that are saying that it’s going to even out are these really intelligent economists that are studying the market and maybe they’re seeing something I’m not. I mean, clearly they’re seeing something I’m not because my local market has nothing.

Scott:
I love this. I’m going to chime in here, on this tangent for a second. So what I think is going to happen based on the opinions of other economists that I follow such as Dave Meyer from BiggerPockets with this is that essentially the Fed said last week, that Friday, I think December 24th, 23rd, or I’m sorry, Friday, the 17th, two Fridays ago, and we’re going to be releasing this in January, so this is way out of date, but essentially they said that they’re going to raise interest rates much more than the 25 basis points that they had indicated previously. That has to have an impact on housing prices, right? I mean, if interest rates go up, people can’t afford the same payments.
So if you were expecting prices to raise with inflation at 6%, 7% next year you’d expect … Or even advance of inflation, having a red hot market, 7% to 10% appreciation, with rising interest rates, you’d expect that to come down, match, or be below inflation. So my bold prediction and who knows if this is right, I’m not necessarily investing on this or changing my strategy based on this, but my bold prediction is that prices will grow next year, but not nearly as much as it did this year. And rents will rise much faster than prices, which will make the rent to price ratio investing a little bit more attractive for investors than maybe it has been over the last couple years as rates have been falling.

Javier:
Yeah, I could definitely see that. Here in the Atlanta area, it used to be, let’s say, 20 offers for every single house and people are still fighting. So now it’s, let’s say four or five. It’s not as much, and so I don’t see that it’s going to be a buyer’s market. It’s still going to be a seller’s market, I would say, but not to the extent that it was in 2021 or 2020.

Mindy:
Yeah, I will say that that is true. So it’s evening out, but it’s still way in the favor of sellers. So you’re not getting 20 offers. Look at it from the buy side, okay, now I’m not competing with 20 people, I’m only competing with five people. The way that a normal real estate market works is you’re competing with zero people. There are enough houses to go around, or there are almost enough houses to go around, or maybe there’s way more houses to go around. What we’re seeing right now is there’s no inventory.
I have a client actually at my house right now and I looked up yesterday, in their price range, there’s 15 houses on the market in all of my city. They only want to live in my city. But it’s insane how unbalanced this market is. So yeah, they’re not competing with 25 offers anymore, they’re still losing out on every property they’re putting an offer in because somebody else has a different set of circumstances. They’re making offers that my clients can’t make. They’re operating under different things. But what that means is there are lots of opportunities to list houses.

Javier:
Yes. Yes. That’s something that I do want to focus on just because the ratio of time spent with sellers is a lot less than ratios time spent with buyers.

Mindy:
And that’s one of the reasons why it’s so easy to list a house, right?

Javier:
Right. Right.

Mindy:
Okay, so I want to talk about paying down your mortgage versus maybe not paying down your mortgage right now. What would you consider a solid emergency fund such that you could quit your job? And this isn’t something that you need to answer right now, I’m throwing this at you out of nowhere. But where does your emergency fund need to be? Where does your real estate income need to be? Where does your wife’s income need to be so that you could say, oh, now I can focus full time on real estate? So that’s a research opportunity that I want you to think about.
And if that’s the case, and you’re throwing all this extra money at your mortgage, maybe you throw all this extra money at your emergency fund instead, build that up in a big way, and then go back to paying down your mortgage. You have a 3.75 interest rate. It’s really high right now, but it’s a really great mortgage rate in the context of historical mortgage rates. I wouldn’t be paying a ton extra on that if I was in your position. But you’ve already said you’re debt-averse, so maybe we shift where your extra money is going right now, so you have more opportunities.

Javier:
Gotcha. Yeah, and the reason that I focused on paying off my mortgage is I always have that what if in my mind, like what if this job goes away kind of thing, and it’s a lot easier to stomach holding myself above water without a mortgage than it is paying that 1,730. I mean, I could refinance and at this point the payment would be like what, $500? And so I don’t know, personally, it just feels better to not have that hanging over my head and I’m just paying for groceries and things like that to survive until I find another job.

Mindy:
Okay, that’s valid. Like I said before, I’m not going to be paying your mortgage. It’s your bill to pay off as you choose.

Scott:
Well, okay, so I think that my instinct, when I look at your situation and say, how do you get to 2.2 million in 15 years? Well, the first one is let’s explore this earning opportunity. Sounds like if you’re making 60 grand, part-time, there’s an opportunity to make much more full time with that. And if the answer is, I’m not comfortable doing that right away, great, pay off the mortgage and then create a situation back into a situation one, two years from now where you are comfortable with at least exploring that opportunity seriously, because I think that’s going to cost you. That’s a big opportunity for you and there might be an opportunity cost for not doing that, given the way that you’ve described your financial profile.
The second question, I think you have after that is okay, but I’m still going to generate surplus dollars after I pay off the house, what should I do with them at that point? Do you have any ideas or thoughts that you want to lead us down before we chime in there?

Javier:
So I was just going to dump everything into an IRA. The way that I was thinking it is I have $1,300 dollars a month. I would put $300 into kids’ college fund, which I think I’m still going to do. And then I could put 500 and 500, or 250 and 250 into IRAs for both me and my wife, and then that would max us out at the 6,000, or I guess we could do 500 and 500, and then that would total us out. But I didn’t know if it made sense to just put everything in the stock market and then bank on it.
And 65, what do we do with the 15 year gap? And that’s where I was kind of wondering, do I only put, let’s say 500 total for me and my wife in our IRA, and then we have 500 that we’re putting to, I don’t know, something else, an after market brokerage account, a [inaudible 00:35:01] something like that? I don’t know. What would make the best sense? If I decide to retire at 50, what’s something that can carry me to 15 years until the IRAs are able to be used?

Scott:
When I hear you saying that, it sounds like you have a large number of competing things that you want to be putting cash towards right now. I have IRAs, college, retirement plans, I heard the stock market. What are the other items there? Let’s list them out. Let’s list out your wishlist here.

Javier:
Honestly, I just want to make sure that I have that 2.2 million at the end, but I have something going in the 15 years that I’m not working, if that makes sense. Now, it could just be that real estate becomes my income and I don’t have to worry about that, but it would just be something where it’s more of a passive income coming in. And I was thinking rentals, but your last conversation where you talked somebody out of it pretty quickly. And I think if you had said those same things to me, I would back out of being a landlord pretty quickly. So I don’t think I would want-

Scott:
What was our argument for the other person for backing them out?

Javier:
You were saying … Oh, they had a very high income and the work and the time it would take for them to learn, to get into that market, to understand how to be a landlord, screening tenants, all of that stuff would not be worth the money that they would be getting out of that. And cutting out the money that it would be getting out of it, it was more the work and the hassle of being a landlord.
I think it’s not what I thought it would be. I thought it would just be an easy, hey, here’s my house, pay me money, and then here’s this cashflow that I have. But there’s a lot more work that goes into it that I don’t know if I’m willing to put in. I’d rather be more of a passive. And it could just be another again, risk-adverse thing that I’m focusing on.

Scott:
I’m going to go on a monologue here for about three to five minutes to answer this question. So here’s the deal. If you earn a tremendously high income from your job or your business, real estate may not be a good avenue for you because the entry point is spending tons of hours learning about and thinking through all of these different types of situations with that. If you want to build a $2 million to $5 million net worth over 10 to 15 years and start in a middle, upper middle class income, real estate can be a potentially great opportunity for you, because you are smack dab in the sweet spot of who I think the BiggerPockets person is, the BiggerPockets member is with this.
You earn right in that $100,000 to $200,000 household income range. You are capable of saving up a sizable down payment on an annual basis, if not a little bit more frequently with a little bit of luck and a good year from the side hustles with this. You are a licensed agent, you could save 2% to 3% of the transaction costs each time, each way on these deals. You have to learn that market anyways, because you’re working for investors with this on your side hustle. I think there are a tremendous number of advantages to real estate investing in your situation that make a lot of sense.
The thing that will be the challenge for you is the lack of willingness to use leverage, and that’s something you have to ask yourself with this. If I invest in stock market long term in an index fund, I expect an 8% to 10% long term compound annual growth rate with that. I know I’m going to have some big years where the market booms, like in 2021, knock on wood, there’s still three days left, or there’s going to be big down years, like in the early part of 2020, where the market can go down by 30% to 50% in those periods. But long term, I believe I’ve got a really good shot at getting that 10% long term yield.
A rental property, the long term appreciation rate is usually in line with inflation at about 3.5%. That’s not been true the last six, seven years, but that’s what I think about when I’m investing long term in these types of things. And if I own a property that’s worth $100,000 dollars and it appreciates 3%, I get a 3% yield and I might get another 5% yield in cashflow on that property as well. That’s an 8% return. That’s actually the same or less than the stock market.
So it’s with leverage that I get that excess return by putting down, if I stick that same 100 grand, instead by 500,000 in real estate, a 3% appreciation rate is 15% on my money, because I’m getting that multiplication from leverage. And I will get more cashflow per dollar invested as well if I make a wise purchase there. So that I think is more the challenge for you getting involved in real estate versus investing the entry price, which I think is potentially well worth it, if you decide to go down that path.

Javier:
Yeah, I think it would be treating the real estate investment side as a business and not so much as a personal thing, because in my mind I was thinking having five houses paid off, that could sustain us kind of thing versus having 15 or 20 leveraged homes that can give me the same income that eventually could be paid off and then I have a larger income coming in from there. So I think that would be my only thing is changing the mindset for investments that I’m doing outside for my own personal income.

Mindy:
I want to say, if I can easily talk you out of investing in real estate, then I want to talk you out of investing in real estate. There is no shortage of podcasts where you can listen to somebody who’s like, “Oh, it’s so easy.” It’s not so easy. It’s not so hard, if you do it right, but it’s work. It’s a job and you are buying yourself a job when you are buying real estate. It doesn’t have to be a full time job, it doesn’t have to be this daunting task. You just have to be aware that it’s a job. And if this is not something you want to do, then don’t do it.
Madison, I think you’re talking about Madison on episode 260, where she moved from San Francisco to Texas and stayed making San Francisco money. She’s making $12,000 a month, she’s spending $7,600 a month, so she’s putting away $4,000 or $5,000 a month. It’s easier for her to do something else. She’s working full time. She doesn’t have the knowledge base to invest in or to start investing in real estate, so she would have to go and gain that knowledge. And I think that’s what Scott was referring to.
So back to your original question, where should you be investing? I would personally invest in the Roth and here’s why. The Roth grows tax free. You put in, I think next year it is … Oh God, I’m completely drawing a blank on what the 2022 Roth IRA contribution limit is.

Javier:
I think it’s 20,500.

Mindy:
Okay, so Roth didn’t go up this year, it’s 6,000. It’s going up for me because I’m going to be 50 this year.

Javier:
Oh, right, right.

Mindy:
Or next year. So it is $6,000 a year. So that’s $500 a month per person. You can max that out. And then all the money, you’re paying taxes now, all your money grows tax free. You’re 32. It’s going to grow tax free. And when you are 50, you can start withdrawing from it. As long as the money’s been in there for five years, you can start withdrawing the principal, if you choose. You can leave it in there if you have other sources of income. But that is my favorite thing is to invest in the Roth because it grows tax free.
If you take this money and you contribute it to an after tax brokerage account, that grows, but you’re going to pay taxes on all that growth. So if maxing a Roth is an option … And you can still invest in index funds through the Roth, it’s just another vehicle to invest, but you have almost all the same options to invest in. You can pick stocks if you choose, I don’t recommend it. But you can pick stocks individually, you can put it all in an index fund.

Javier:
So one question I did have, based on what you just said, you said I could touch that money at 50 in the Roth IRA?

Mindy:
I said at 50, because that’s when you’re planning on retiring. You can touch the principal of your Roth IRA, the money that you have put in, you can touch that after it’s been in there for five years. So you could do that.

Javier:
Okay. And it won’t be penalized or taxed or anything?

Mindy:
It will not be penalized or taxed or anything, because it grows tax free.

Javier:
Okay, good to know.

Mindy:
But I don’t think you can access that before five years. Scott, do you …

Scott:
I think that you can withdraw the contributions you make anytime, tax and penalty free. If you are doing a rollover from a 401k into a Roth IRA, then the principal cannot be touched for five years.

Mindy:
Maybe that’s what it would be.

Javier:
Okay.

Mindy:
Okay. There are so many rules with all this stuff, they sometimes get crossed. But yeah, that makes sense, because I knew it was with the Roth conversion, it had to be five years.

Javier:
And then one other question that I had is do you guys think that I’m allocating too much to taxes? So right now I’m doing 30% because that was a rule of thumb, but I always have a little bit more in our taxes account after we have to pay for our taxes. Is there a better number I should be using? Should it be less? Should I just keep it that and just know that I’m going to have a leftover?

Scott:
This is where I think doing some research and planning and maybe considering having a CPA in your life more than just once at the end of the year, maybe like three meetings a year for an hour type thing might pay off really nicely because I think you essentially have to guess at what your income is going to be. And it fluctuated from 5,000 to 60,000 in one year. It could be much more next year and each incremental amount puts you in a higher and higher overall income tax bracket with that.
So I like the 30% for now not knowing anything else and saying that’s too conservative, knowing that might be a little bit conservative. But not knowing what’s going to happen in 2022, I don’t think there’s anything inappropriate with that at all. And I think that having it in a low risk, high yield interest thing, it makes a lot of sense. Unless you decide you want to get much more careful and calculated about how you’re going to account for that. Towards the end of the year, as you get more certain as well, you can probably begin dwindling it a little bit because, hey, my income’s going to be right around this level this year, therefore my tax bill’s going to be this, therefore I can pull a little bit more out.

Mindy:
Are you paying estimated taxes or where does this 675 go? Is it just sitting in your own bank account that you control? Are you paying the government?

Javier:
No. It sits in a bank account until the end of the year, and then I do my taxes and then it’s just like a huge bill.

Mindy:
Okay.

Scott:
And I would talk to the CPA … Sorry, Mindy, go ahead. You were about to give him the same point I was about to.

Mindy:
I was about to give him the same point. Talk to the CPA. Are you paying any fines? Because I think after a certain level of income on a 1099, you need to pay quarterly estimated taxes. And this is something that I only know enough about to say, go to a CPA. But I want to make sure that you’re not paying fines on this. And it could be that you have enough W-2 income to cover that so that you don’t have to pay the quarterly taxes, but that’s one of the-

Scott:
I’ve never paid any fines, so.

Mindy:
Okay. Well, I’m glad you’re not paying any fines. I don’t like paying more to the government and then getting a tax refund. I would much rather owe the government in April because I have the ability to pay that check. It’s not a huge check. Most of my real estate commissions go into my 401k.

Scott:
So I have the same thing here. I have a book that I have written and receive royalties on, I have ownership in private companies and syndications that produce income. If I’m having a year where I think I’m going to have a sizable amount of income from these side things, contracts or royalties or ownership interests on a K-1, then I try to pay those quarterly taxes.
When she’s asking if you’re paying a penalty, what I think Mindy’s asking is, if you’re above a certain level of income, and I’m not exactly sure what that is, you pay a 3% interest rate at the time you pay your tax bill at the end of the year on all of this money. And you’re probably earning less than that in your savings account right now.
So because, based again on our conversation, I don’t think you’re going to take that money and invest it aggressively to try to arbitrage between the 3% penalty or the interest rate that the IRS is charging you and your investment yield on the stock market or a real estate property. That just doesn’t seem like it’s your nature based on the conversation we’ve had so far.
So I think that’s where a good CPA comes in and say, here’s what I think my income’s going to be that is not going to have federal taxes withheld, and I’m going to pay that throughout the year in installments, so I don’t have to pay this 3% interest rate. I’m butchering that. A CPA hopefully can come in and correct my terminology that I’m using to describe this phenomena.

Javier:
Okay, perfect. This was my first big year with real estate, and so I think this is the only time that I’ve been a little wary about it. Prior, it was like 2,000, 5,000 and then this was just a ginormous jump for me, and so I just want to make sure that I’m preparing properly for that.

Scott:
Yeah. So that should solve your problem too, of how much am I putting aside for these tax bills? Well, great, in Q1 … I think the estimated tax schedule is actually not like Q1, Q2, Q3. It’s like January, February, March, April, then June, July, then three months, then three months. It’s like four, two, three, three, or something like that.
But that’ll solve your problem because you say, okay, in the first quarter I earned 30 grand and I’m going to set aside 30%, pay my estimated tax bill, and then know that I can dump any remaining sum back into my emergency reserve or towards my mortgage with that. Then you do it again each quarter. So I think it will essentially resolve your problem because you can be conservative for a much shorter period of time with your tax withholding and then plow it into the next place that you want to do it.

Javier:
Yeah. So I just want to make sure I understand. So if I pay my mortgage off, then essentially put that money into a Roth IRA based on what Mindy was telling me. And then for my real estate income, build up an emergency fund so that I could focus on maybe making that my primary job in the future.

Scott:
Yeah. So here’s the paradox or the challenge you’re going to have, again, one hour into knowing you on this call today with this, is because you’re so conservative, it allows you to concentrate more heavily on the highest impact things in your situation. You don’t earn $250,000 a year or some huge amount of money and can go down this gigantic list of optimal investments like HSA, Roth IRA, 401k match, college savings plan, then real estate properties and pay off the mortgage. You can’t do it all with that. You’re doing great. You can do a lot of things, but you can’t do them all. So you need to come up with an ordered list of the most effective ways to allocate your cash better in line with your values and your goal of getting to $2.2 million in 15 years.
To me, an example of that list, I don’t know if this will be the one that you end up settling on, but an example of that list would be okay, great, every excess dollar I have is going to go towards paying off my mortgage early. When that’s done, I’m going to build up a 6 to 12 month, or let’s call it 12 month emergency reserve. That’ll be $60,000 in cash, right? Not something that some other people do, but maybe that’s something that makes sense in the context of this.
Then I’m going to move into real estate full time. From there, I’m going to generate surplus dollars. I’m going to plow them into my Roth IRA first. Then I’m going to make a decision about whether I want to go down this cascading tax advantaged investing strategy with HSAs, college things, or if I want to pivot and begin allocating more dollars into real estate investments with that.
You won’t be able to do it all, so I would go all in or commit heavily to one of those areas, especially in the first few years. If you end up having a problem in five years where you’re able to generate $300,000, $400,000, $500,000 from your real estate business, then of course you can do it all and that’ll be wonderful. But I think that that’s where I would start. I think that those two or three make a lot of sense to me at first. And then from there, you have a choice about where you want to allocate, whether you want to go down this route of funding kids’ education plans, or real estate.
And for what it’s worth, personally, I don’t have kids, but I think that what I’m likely to do pending further discussion with my wife and all this other stuff, but I think what I’ll probably do is simply buy real estate to fund their educations and those types of plans, because I believe that building the greatest net worth, the best risk adjusted investing strategy to build long term net worth without going zero or eroding the principal there is the best way to fund things like college education or opportunities for future kids, rather than locking it into a 529 plan, which has one use.
And it may be the most advantageous way to save for college expenses, but they may not go to college. They may go to a state school, they may get a scholarship. There may be all these other things that happen with that. And having it flexibly in real estate, to me makes more sense, but that’s a decision you’re going to have to think through and I don’t think there’s a right answer to that one.

Mindy:
I have two kids and my oldest is 14, she’s a freshman in high school and I have, boy, send these messages to [email protected], but I have $0 allocated towards her college fund. And that doesn’t mean that I have $0 available for her, but I have put nothing into a 529 plan because they can be so limiting, and I have a way to pay for it, and I also never got around to it. And wow, again, send all those messages to [email protected], not me about how bad that is. But I have the ability to pay for her college.
I also want her to have some skin in the game. I want her to work hard in college, if she chooses to go. And right now she wants to be an occupational therapist. If she chooses to go to college, I want her to work hard. I want her to feel like she needs to get some scholarships in high school. I want her to have some ownership of this. I feel like I wasted my college studying fashion design because I don’t do anything with it. So it would’ve been a better use of my parents’ money to go someplace else and study something a little more-

Scott:
Here’s one from Brandon Turner that I think is just awesome and probably what I’m going to do, or a similar concept to what I think I might do with this, is you buy a duplex, a triplex, or a quadplex. You put down $60,000, let’s call it 240,000, 300,000, something that’s right in the ballpark of what you do on a daily basis for these investors. You put it on a 15 year note. Your kids in 15 years are about to go to college. Your note is almost entirely paid down.
And you have to buy a good deal that allows you to cover that cashflow or supplement it a little bit with your income, if you want to apply this strategy. By the end of that, your loan is almost or entirely paid down, and then you cash out, refinance the property, pay down the college, and put it on a 30 year note, and then do it again. And now you’ve got the kids’ college education paid for.
That’s an overly simple way to think about the strategy. There’s tax reasons why you might not hold onto the property for 45 years. But that’s a really good framework, I think for thinking about it, that it doesn’t have to come from the 529 plan necessarily.

Javier:
That makes sense. And we don’t actually have a 529. We have a non-retirement mutual fund. I think that’s what my, not CPA, but my financial planner called it. So if they decided not to go to college, they can use that funds for things outside of college. But it was more of just having something there for them that they can have, whether if they wanted to start their own business, or they wanted to go a different route. It didn’t have to be school. But I like that strategy of buying the house because it’s something that not only could cashflow me, it could be $100, $200, but it’s still making money for me while it’s also giving them an opportunity to, like you said, refinance it and have that money at the end when they’re ready to graduate.

Scott:
Well, great.

Mindy:
Yeah, I’m looking-

Scott:
But I think that’s the big challenge is you can’t … I was a little alarmed by, hey, I want to do all these different things with my investing. I think that’s going to get you a whole lot of mediocre to poor returns by trying to go too far down that list with your current situation. I think I would focus on the big items first and go down and make an ordered list. Perhaps the first three or four items look like the ones I mentioned, but I think that’ll be your challenge there. And then I’d just attack it and be like, boom, mortgage knocked out, boom, emergency reserve, starting my brokerage, now maxing the Roth. Now, okay, great, I’ve got a big surplus. Now, I’m going to go and relook at that list and reprioritize and go as far down as I can get.

Javier:
I like that strategy, because I think in my head, I say 10 to 15 years, but in my heart it’s more like I want to do everything in two years. And so I think that gives me a realistic, hey, you can’t do everything. So based on my personal finance strategy, I think that’s a great way to think about it, so.

Scott:
And I just think that by far the highest return to me right now from your position is starting your own brokerage with this. If you’re earning 60 grand on the side right now, I can only imagine how much you’ll earn full time with that. And so that seems like a big opportunity.

Javier:
Okay. Yeah, I think I’ll have a lighter heart when it comes to these things, because if I do pay off this mortgage, I feel like that’s that looming thing over my head right now, where it’ll allow me to breathe easier, knowing that if I do slip up or I do make a mistake or something like that, I don’t have that huge payment that I have to cover. It allows me to be a little more riskier when I don’t have that hold against me.

Scott:
Then the cost of that mortgage is not 3.75%, and the ROI of paying it off is much, much greater.

Javier:
Good to know.

Scott:
All right, anything else we can help you with today?

Javier:
No, I think that was it. You guys gave me a good line that I should be following instead of trying to grab everything at the same time. So I think I’m going to be setting that up, talking with the wife to make sure that we are aligned on that. I think Mindy gave me a great perspective to say that, hey, if I don’t invest anything and whatever, the market does what we think it possibly per chance could do, that I could be set with my goal by the time I’m 65. So it’s just more of how do I get there a little bit faster.

Scott:
Awesome. Well, I think this is a really fun discussion. You had a lot of fun challenges and nuances for us, so thank you for the unique situation that you brought and for the great discussion today. We really enjoyed it.

Javier:
Thank you guys so much.

Mindy:
Yeah, this was a lot of fun, Javier. Thank you so much, and we’ll talk to you soon.

Javier:
All right. Take care.

Scott:
All right, that was Javier. Mindy, what did you think?

Mindy:
I love the opportunities that he has opened to him based on the financial choices that he has made that have kind of been ingrained in him since he was born. He said that he was a frugal person because he is first and second generation immigrant and his parents pushed home the value of frugality. I don’t know that spending $6,800 a month is necessarily frugal, but he certainly could be spending a whole lot more according to just normal American consumption. So he’s definitely conscious of his numbers, which I think is one of the most important tools that he has in his tool belt, just being aware of where his money is going and how much of his money is going there every week, every month.

Scott:
Yeah, and what I think is really important to call out here is Javier is one, very frugal, or more frugal than his numbers might appear at the highest level. And two, that he’s very risk-averse with that. And paradoxically someone who’s very risk-averse actually has an opportunity to take on more risk and may get to financial freedom faster, if for example, he is able to go and start that real estate brokerage, or make that a full time endeavor with him.
One of the things that Mindy called out in the intro and again, we discussed with Javier after the recording was the concept of figuring out your bare bones expenses with that. And that’s really important here because Javier is again, psychologically very risk-averse. He needs to pay off his mortgage and he wants to build probably a one year I’d imagine emergency reserve prior to starting his business.
But note that two components of his expenses are huge. One is his mortgage payment at 1,730. And remember, that’s on a 15 year note at a 3.75 interest rate, which is a relatively high interest rate and obviously a faster amortization period. So that will get essentially eliminated to just taxes and insurance once the balance is paid off there.
And two, he gives away 10% of his income, or more than 10% of his income, $1,000 a month he said, to his church. And if his income were to evaporate and his mortgage were to be paid off, he would no longer have either of those two large expenses reducing his monthly spending by nearly $2,000, $2,500. If you’re planning on a year long emergency reserve, that’s 30 grand.
So not only is there a lot of money that he’ll be bringing in more money from his monthly cashflow, excluding his agent sales, his side hustle, once he pays down the mortgage, but he also has a bare bones budget that I think is much lower than what he described there. And so, again, that’s important because that’s the next pivot point in his journey. He has a decision to make once he gets to that point about whether he wants to pursue this full time or take on a more aggressive investing strategy or something else.

Mindy:
Yeah, I like that he has time to figure this out. He said, I want to do this, I say 15 years, but I want to do it in 2. He’s got a lot the time to figure out where he wants to go before he actually has to make the decision. He wants to save up more for his emergency fund. So as he’s doing that, he can weigh these different options, ooh, if I did this, then that would happen, if I did that, then this would happen. So I love that he’s got a little bit of time to pursue this, but he’s starting off from such a great position.
And this is where I really agree with Dave Ramsey up to baby step number three is get rid of all of your consumer debt. Having these debts, having these obligations that you have to pay, even if it’s just the minimum amount, that’s money that you really can’t choose to spend someplace else. Javier chooses to spend money in different places because he doesn’t have this debt looming over him. He doesn’t have a credit card payment. He doesn’t have a car payment. He doesn’t have a student loan payment. He just has his mortgage. So he can choose to pay extra to his mortgage, or he can choose not to.
But spending less than you earn, earning more income, these four levers that we talk about all the time, spending less than you earn, earn more income, entrepreneurship and investing wisely, we should throw in a fifth with one, is pay off your debt, be debt free, consumer debt free. And I don’t include the mortgage in that big group, but be consumer debt free. It just opens up so many more options for you. Yeah, he’s impatient because he’s so excited about this and that shines through in his show, but he will get there. He won’t get there tomorrow, but he will get there and he will get there very comfortably. Because he is so risk-averse, he’s doing all the right things.

Scott:
Yeah, and I think one other additional observation is, this could have been a Dave Ramsey podcast minus my … I don’t have the soothing baritone that he does [crosstalk 01:05:04] unfortunately, Mindy with that. But I think that if you’re going to follow Dave Ramsey’s baby steps, follow them and take the advantages that come from that strategy. There’s trade offs with it. You’re not going to be able to arbitrage low interest debt rate for higher yield investment opportunities, like the stock market, over time with that. That’s a cost.
But you are going to have a very low fixed amount of annual spend because you’re going to have a paid off house, no consumer debt, control over all those expenses. Use that to your advantage in a business venture or something that has the potential to generate really high returns once that’s achieved. I mean, that’s the power of his plan, and I think that it’s worth acknowledging that in the context of the discussion we had with Javier today.

Mindy:
Yep, absolutely.

Scott:
All right, Mindy, should we get out of here?

Mindy:
Let’s do it.

Scott:
From episode 272 with the BiggerPockets Money Podcast, she is Mindy Jensen, I am Scott Trench saying, fly eagles, fly.