Afford Anything - Ask Paula: How Long Will It Take Me to Become a Millionaire?

Episode Date: November 25, 2020

#286: Kaitlyn has $78,000 saved for a property, but she isn’t sure whether she should buy a personal residence, a rental property, or both. How can she best use this money? An anonymous listener wants to lower their housing expenses. Should she and her husband buy a cheaper property and turn their current home into a rental, or should they stay and pay off the mortgage as quickly as possible while saving for a downpayment on another property? Alex is just getting started with financial independence and asks: how can you calculate your financial independence date, and how do you know how much you need to save to reach that number at a certain age? Ell wants to know: what’s the difference between a high-yield savings account and a money market account, and how can you maximize the interest you earn in these accounts? Jenn wants to know: is it possible for Canadians to find cash-flow positive real estate deals, either in Canada or the United States? I answer these questions in today’s episode. Enjoy! For more information, visit the show notes at https://affordanything.com/episode286 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to your time, your focus, your energy, your attention, any limited resource that you have to manage. Saying yes to one thing implicitly means. Saying no to many other options, and that opens up two questions. First, what matters most to you? Not what does society say should, but what actually matters most in your own life? And second, how do you align your decisions on a daily, monthly, yearly basis to reflect that which matters most?

Now, answering these two questions is a lifetime practice, and that is what this podcast is here to explore. My name is Paula Pant. I am the host of the Afford Anything podcast. And today, I will be answering questions that come from you, the community. Here's what we're going to cover. Elle is saving up for a down payment on a house, and she wants to put her savings in an account that's going to make her some amount of money, she wants to know what's the difference between a high-yield savings account

and a money market account. Alex is 25, just graduated, and is starting at a job that pays $50,000 a year. She wants to know how much she would need to save in order to retire with $1 million, and also how to calculate her financial independence date. Caitlin is a public employee in Alaska, and despite the fact that she can only save a few hundred dollars every month, she has accumulated $78,000. What should she do with this?

Anonymous and her husband are 32 years old and live in Austin, Texas. They want to get started with rental properties, but the home that they're currently living in would not make for a very good rental. Should they remain in their current home and focus on buying a second home to use as a rental, Or should they move out of their current home and turn that home into a rental property despite the fact that it wouldn't make good money? Or should they sell their home? What's the next step?

Jen lives in Canada and wants to know what recommendations we would give to a Canadian who wants to get started with real estate investment. We're going to answer all of those in today's episode, starting with Elle. Hi, Paula. This is Elle in Portland, Oregon. I have a question about high-yield bank accounts. So I'm saving to make a down payment on a house, and I have about $40,000 in my savings account at a traditional bank. And the interest rate for the account is super low. It's like 0.01%.

So I think it would be smart to open a savings account with a higher interest rate. I have heard about both high-yield savings accounts and money market accounts, and I've done some research online and in your forums, which are awesome, by the way, thank you. And it sounds like allied bank is a good option. So my questions are, what's the difference between a high-yield savings account versus a money market account. How can I think about choosing one of those? And how should I set up my bank accounts to maximize my accounts in terms of interest? Because I've read that it can take a few days to access money and high yield accounts.

So should I be keeping like $1,000 in my traditional bank checking account in case I need to access it quickly? Thanks so much. I really appreciate everything you've been able to bring to people through your podcast and your real estate course. And yeah, I'm excited to hear your answer. Thank you. Al, I love this question. Okay, so let's start with what's the difference between a high yield savings account and a money market account? That's a great question. Now, first of all, let's talk about ways in which they're similar. Both a savings account and a money market account are interest-bearing deposit accounts, meaning you deposit money and you make some amount of interest. Both of the accounts are also insured. And that's an important

thing to know because if you open a money market account at a bank, it will be FDIC insured. And if you open it at a credit union, it will be NCUA insured, which means that your deposit will be insured even if the institution goes out of business, up to a certain maximum amount. Now, the reason that I point that out is because there's a distinction between a money market account and a money market fund. And it's very easy, because the name sounds so similar, it's very easy to get them conflated. So a money market account is FDIC insured or NCUA insured. A money market fund is not.

Now, depending on where a money market fund is located, it may be insured by something called the SIPC, but that's neither. here nor there. This conversation is about savings accounts versus money market accounts. So when you are looking at those two options, make sure that what you're looking at is what's abbreviated as MMA, money market account, make sure that it says account and not fund. We've talked about ways that the two accounts are similar, savings accounts and MMAs, right? They're similar insofar as they are both FDIC insured interest-bearing deposit accounts. In those ways, they are similar. Now, Historically, it used to be that money market accounts paid slightly higher interest than high-yield savings accounts.

These days, that isn't really the case so much. Back in the early 2000s, if you were looking at savings accounts versus money market accounts in 2005, the money market account most likely at that time would have had a higher interest rate. But these days, capital is so cheap that there are pretty much, Low interest rates everywhere, and the rates that you're going to find at either savings accounts or money market accounts are going to be more or less neck and neck and universally bad. Now, I don't say that to be a pessimist. I say it because the flip side of it is that borrowing is very cheap, right? And when borrowing is cheap, that means that saving is expensive. Low interest rates result in a low interest rate environment which harms savers and helps borrowers.

That's how low interest rates spur the economy by encouraging borrowing, which is why it's in a situation like we're in right now where you're not getting very good returns on the money that's in your savings account or in your money market account, but you're also getting rock bottom mortgage rates. So when the cost of capital is cheap, when lending happens at low interest rates, that means that savers are not going to see high interest rates in any of their savings accounts. And right now, between savings versus money market, it's 601.5. a dozen of the other. Now, there are a few administrative differences. Money market accounts often have features that are found in checking accounts. So, for example, you can usually write checks

out of a money market account. You may even be able to get a debit card out of a money market account. So in those regards, it differs from a savings account. However, because it has interest rates that are comparable to what you'll find in a savings account, your total number of transactions like withdrawals or transfers are limited to six per month. So despite the fact that it has those checking account features, debit card checkwriting, it is not an account that is set up for you to use those features routinely in the way that checking accounts are. That limit of no more than six transactions per month means that it's not intended to be a replacement for a checking account. but if you don't make a whole lot of transactions and you're looking for an account that gives you a similar interest rate to savings accounts, but gives you the ability to occasionally use a debit card, maybe once or twice a month if you want to, a money market account can fill that role. It can serve that purpose. And that leads to the other component of your question, which is how do you organize your money in such a way that you're making the most out of the deposit in either a savings account or a money market account, whichever one you choose?

My recommendation would be to keep enough money in your checking account to cover at least, certainly at least, the next month's worth of expenses, all your expenses. Rent or mortgage, groceries, phone bill, random 1 a.m. Amazon shopping, that rogue bottle of wine that you order on a whim, keep enough money in your checking account to cover at least a month of it. Honestly, I think a month is maybe too little, ideally about two months. in a checking account directly. I know it's going to be making almost nothing, but it gives you a cushion that protects you from overdrafts. So what I like to do is I keep that cushioning inside of a checking account so that that way I'm not frantically checking the balance of my checking account,

worrying about, okay, I paid this bill on Tuesday and I paid that on Thursday. And if that thing pulls before this other thing deposits, then I might not have enough money in the checking account. Like, I got things to do. I got other things to think about. I don't want to be constantly micromanaging my checking account. And so having that cushioning in there that keeps me from needing to obsessively worry about the dates and times when everything is going to get pulled, having the cushioning that keeps me from needing to micromanage it, that freedom to me is worth any tradeoff in potential

very, very low interest that it would otherwise be making in a savings or money market. account. So keep that cushioning in there. And then for the remainder of your money, the stuff that you're using to save for big ticket items like a down payment, that money can go into a savings or money market account. So thank you for asking that question. I'm glad that you're enjoying the community forums. That's awesome. I've been doing Zoom hangouts of seven of them in the last three days, all with people from the Afford Anything community. And on several of these Hangouts, people have talked about how much they enjoy the community, how much they learn, how excellent it is to be able to get immediate insight and feedback on whatever personal

finance or life question is on their mind. I'm glad that you're enjoying it. I'm glad that they gave you good pointers on where to turn to. And best of luck with all your goals. Thank you, Elle. Our next question comes from Caitlin. Hi, Paula. Thanks for the show. I really enjoy listening to answer the questions people don't realize they're asking. I'm lucky to still be employed as I work for the government and our budgets won't immediately be affected. So I'd like to get your thoughts on my first real estate move that I hope to make in the next one to two years. As a little background, I'm a public employee in Alaska. I love my job, but after other savings, I can only save a few hundred dollars a month towards real estate. I currently live in a lovely studio that's way below market rate,

and will be converted into a one-bedroom this summer. You have already sold me on out-of-state rental properties, and I like that I could invest somewhere that isn't so tied to the oil market. I have about $78,000 saved, and I was going to use it for a personal residence down payment, but maybe I can use that money in a smarter way. Ideas so far are to buy an out-of-state rental property, then re-save for a personal house, or buy the personal house and rent it out to offset cost,

while living in my inexpensive rental, or try to do both, though I'm not sure I have the cash for this. I don't know about how the purchase order will affect things like first-time homebuyers programs, how lenders view me, interest rates, and probably other things I'm not thinking of. I want to be strategic since my income is limiting at the moment, so I'd love any input and ideas you have. Thank you. Also, I don't know how you make a podcast because it took me 10 times to record this question. Thank you. Bye. Caitlin, first of all, congratulations. You've saved $78,000. That's enormous. You know, we have not done this in a while, but this deserves a sound effect.

Steve, can we get a sound effect? Congratulations, Caitlin. That is so well deserved. And as you said in your question, you can only save a few hundred dollars a month. The fact that you were able to accumulate such an enormous amount, And I know what that's like. I know what it's like to not earn a whole lot in your day job and have to save a little bit at a time for a very long time. And it is hard. It requires a lot of persistence. It requires a lot of determination. And it's such an amazing thing. Once you've done it and you can look back and have the pride that comes from knowing that you set this goal and you stuck with it, That's incredible. So huge congratulations to you for saving $78,000 on not a huge income. All right. So let's talk about how to use that wisely. So as I heard you list out those three options. You know, option in no particular order, option one is buy an out-of-state property and save up for a personal residence. option two is buy a personal residence and then rent it out to offset its costs while you're living

in your own inexpensive rental. And option three is to do both, although that might be a little tight. Let's put aside option three for the moment, since it sounds as though that might be the hardest one to execute. And let's look at options number one and two. And let's start, you know, actually, let's start by examining number two first. So let's start by examining using this money to buy a personal residence and then renting out that personal residence while you continue to live in this inexpensive rental that you're currently living in and that you enjoy living in. The first question, the first follow-up question that comes to mind is, would your landlord allow you to sublet the place that you're currently renting for one

year. And the reason that I ask that is because if you were to use this money to buy a personal residence and you were to take out a primary resident mortgage, then per the brand new primary resident mortgage that you're taking out, you would need to live in that property for about one year. Now, I should say, I'll add the caveat that when you take out a primary residence mortgage, there is nothing official within the lending documents that says, like, you're required to live here for 365 days, starting from, you know, within 60 days of the close of this mortgage. There's nothing official that's baked into the documents. But in order to make an argument, if questioned, that you did sincerely purchase that property as a primary residence,

it is considered standard to live in a property for one year such that later, you know, if you live there for one year, then you move out, let's say you live there for one year, during that one year, you sublet the place that you're currently renting. And after the end of that one year, you move back into the place that you're currently renting, since it sounds like you enjoy living there, and then rent out the thing that you bought on a primary residence mortgage, you use that as a rental property. The benefit to that is that you've only lived there for one year, but now you have 29 years of getting the benefit of a primary resident mortgage, which is going to have a lower interest rate than a second home loan or an investor loan, you have the following 29 years of that benefit. The reason that you want to live there

for one year is so that if the bank ever were to question you and say, hey, you know, were you telling the truth when you applied for this as a, for the use as a primary residence, you can say, yeah, absolutely, I live there for a year. And that's my proof that I was genuinely telling the truth, because I did take out this mortgage for primary resident use, and I did use it as a primary residents for a year. And look, here are my electric bills. Here's my heating bill. Here are my paychecks going to the address of that home. Here's my updated driver's license and voter registration, all tied to the address of that home. So see, I live there for a year. That means that when I was applying for this mortgage for use of primary residence, I followed through.

Now, in order to make that work, of course, you would need to sublet the place that you're currently living in. And so that is my number one question. Would your landlord allow you to do that? Because if so, that sounds like the best option. That way you get to keep the place you are renting and you get to buy a rental property with a primary residence mortgage. So you'll get the best of both worlds as long as you can sublet out your current home for a year. If your landlord doesn't allow you to do that, the other option would be to purchase an out-of-state rental.

And that can fork in a couple of different ways. So you could take the $78,000 and use it to buy an out-of-state rental in cash. Or you could use the $78,000 to make a down payment, let's say a 25% down payment, on an out-of-state rental that you are borrowing the other 75% on an investor loan. Investor loans typically will have between 25 to 30% down payment requirements. So I'm taking the lower of the two numbers. And I am not factoring for the cash reserves that you would want to have on hand prior to going into the investment.

So once you factor for those, maybe you'll buy a rental property that's valued at $180,000, you will use $60,000 as the down payment plus closing costs and other ancillary costs. And then you'll start with $18,000 remaining in cash reserves that you can use for any unexpected upfront repairs or you can just use to have a really strong emergency fund for that property. Those are broad hypothetical numbers, but I'm basically trying to walk through the two different forks of if you were to buy an out-of-state rental, would you want to buy one property in cash? or would you want to use a portion of this money as a down payment on a property that you would finance? Now, there are pros and cons to both approaches. The benefit of using this money to buy a cheap property in cash is, obviously, that you wouldn't have any debt. And that gives you greater cash flow and better wiggle room, you know, more margin of error.

If something goes wrong, it's much better to have something go wrong on a property that you hold free and clear. there's more forgiveness, more space to make mistakes, more space for error. That being said, the quality of property that you would be able to buy at $78,000 may in and of itself present other risks. So if you think of risk as existing in multiple dimensions, you have leverage risk, which is what we're addressing directly right now, but then there's also risk associated with the age and the condition of the property. And then there's also risk associated with the average duration of tenancy slash average rate of turnover in the neighborhood in which you're buying. And so all of these different verticals are different types of risk. And if you

diminish leverage risk by buying a property in cash, then oftentimes because that narrows the scope of the properties that you are able to buy down to a specific subset of properties, reducing your risk when it comes to leverage might require the trade-off of increasing your risk when it comes to the age and condition of the property, or the amount of vacancy in the neighborhood, or the frequency of turnover in the neighborhood. And so it would be too simplistic to say that you're reducing risk by buying a property in cash. You're reducing a form of risk, but that may come at the cost of increasing other forms. Now, those are the considerations with regard to using that $78,000 to buy an out-of-state property in cash. Let's say, by contrast, you used that $78,000

to buy an out-of-state property that you financed, well, the downside, of course, is the risk that is inherent with leverage. The upside is that you may be able to buy a nicer property, or you may be able to buy a duplex. In a lot of places, a property that sells for $180,000, $180,000, $200,000, in which you could make an investor down payment on a $200,000 property and still have ample cash reserves to spare, well, that $200,000 property could very well be a duplex out of state, which then gives you the economies of scale of having multiple doors on a single plot of land.

It gives you income diversification between two units, such that if one of those units is vacant, the other one might still be occupied. More units means more streams of income, which means that if there is anything that goes wrong with one of the units, you still have the other unit working for you. And in that regard, that offset some of the risk. So zooming out, as you can see, a lot of what we're talking through right now is risk management, and we're talking through it through the lens of recognizing risk as existing in multiple

dimensions. If you think of different sliding scales, sometimes when you turn the slider in one direction on one scale, it necessarily causes the slider to tip on a different scale. And so I think the question that you need to ask yourself is, of these different variations of risk, which one am I most comfortable with, I meaning you, and which one do you most want to take on? Would you rather have a duplex in a Class B neighborhood so that you can get the benefit of having two doors in a relatively stable location? Or, you know, would you rather buy something free and clear? Or will your landlord just let you sublet your place for a year? In which case, this whole out-of-state conversation could be made moot because that

way you would get the best of both worlds right there in your home state. You would be able to buy a personal residence that eventually you could move into whenever you were ready. And in the meantime, as long as you're enjoying the place that you're currently living and you can rent it at a very competitive rate, you can continue enjoying the benefit of this property that you're currently renting. That seems to be the ideal solution since it would give you both a personal residence, which it sounds like you want, and a rental property with very favorable mortgage terms, which is fantastic. You know, it would give you both of those in one purchase. Oh, and if you go to your landlord and your landlord says, no, I don't allow

subletting, remember, landlords can negotiate. So this happened with me once. A tenant came to me and said, I want to sublet my home. And I said, no, I'm sorry, I don't allow that. And the tenant didn't take no for an answer and very politely came back and said, can you tell me, what are your concerns? Why is it that you don't allow that? And I said, well, you know, my concerns are that I have no ability to vet that person. I don't know if they have been evicted from the last 10 places that they've lived in. I don't know if they're going to cause trouble. I don't know if they're going to pay rent. And oftentimes, when a sublet happens, I didn't get to choose the person who's living in this home that I own. And yet, when that person destroys the property or doesn't pay the rent

or some issue occurs, the tenant doesn't want to deal with it and essentially passes that problem on to me, the landlord. And so what I said to the tenant was, I don't allow suburb. letting for precisely that reason. And then, you know, the tenant said, okay, I understand. And then we continued talking about it and we sat down together and really discussed the matter at length and came up with a plan in which essentially the tenant guaranteed that the tenant would be responsible for whatever happened. And then we drafted and signed an ironclad agreement that essentially said everything that we talked about, that the tenant does have the right to let, but if anything, anything, anything, anything at all goes wrong, then the tenant has to deal with

it. That's on the tenant. Any damage that's done to the property is the tenant's responsibility to fix. If the subletter does not pay rent, it's up to the tenant to make up the difference. So we sat down, we hammered out a very clear agreement. It took some time and it took multiple discussions, but that's an example of a tenant successfully negotiating with a landlord who did not allow subletting and who that tenant eventually convinced their landlord, me, to allow subletting. So remember, everything is negotiable. So those are the options that I see in front of you. And regardless of which one you choose, congratulations on saving $78,000.

That's incredible. You're clearly good with money. You're clearly very responsible. You're detail-oriented. You're on top of it. and I'm very hopeful that regardless of what you choose, you will be building your net worth and setting yourself up for a very strong future. So congratulations again. We'll come back to this episode after this word from our sponsors.

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Fifth Third Bank has the big bank muscle to handle payments for businesses of any size. But they also have the fintech hustle that got them named one of America's most innovative companies by Fortune magazine. That's what being a fifth third better is all about. It's about not being just one thing, but many things for our customers. Big Bank Muscle, Fintech Hustle. That's your commercial payments of fifth-third better. Our next question comes from Alex. Hi, Paula. This is Alex. They-them. First of all, thanks so much for all you do. I really love this show and everything you do for the FI community. I've been listening for a little while now, and I'm pretty excited because I just got my first job and I'm ready to start saving.

A bit about me. I'm 25. I just graduated grad school. Luckily, I had a lot of family help, so I didn't graduate with any debts, and I worked my school a bit, and I currently already have saved an emergency fund. I'm about to start a job for 50K a year, and I just have like two math questions for you. I need help running the numbers. So I know from reading that it's possible that you can save a certain amount of money between the ages of like 18 and 25 to retire with a million. If I wanted to start front-loading it like that, and I just continued living like a college student and maxed out my retirement accounts, even though I have a 0% company match, I was wondering if it would be possible for me to still, like, max it out for a couple of years at the beginning and still end up with a million dollars at the age I wanted to retire. I wanted to know how to run the numbers to figure out how much I would need to save and how many years. I would need to do that for.

The second question is another math question. A lot of people talk about their debt payoff dates, but I'd want to know how to calculate my like phi date. I currently plan on just having the one job without any like side hustles or any other sort of income, but I'm interested in becoming financially dependent. If I were able to do the front load savings method, I mentioned for retirement savings when I'm 65 plus,

how do I figure out how much money I need between 65 and wherever I end up. So say like 30 to 65 or something if like, for example, my expenses at that point are like $2,500 a month. If you'd help me out with these and maybe tell me how to calculate math like this, I'd really appreciate it. I love the show and everything you do. Bye. Hey, Alex, first of all, congratulations on finishing grad school, having an emergency fund and having your head in the game, like you've got everything in order, you've finished grad school, you're starting this great job, you have no debt, you have emergency savings, and you're thinking about how to build financial independence, and you're doing this all at the age of 25. So congratulations

on, by age 25, putting yourself in a position for a really awesome future. Now, let's talk about both of your questions, starting with question number one, which is, how long will it take for you to become a millionaire. As you mentioned, you know that if a person hypothetically were to save money, a certain amount of money between the ages of 18 and 25, then hypothetically, starting at the age of 25, never contribute another penny again. Mathematically speaking, depending on the amount of money that they contribute between the ages of 18 to 25, and depending on the assumption about the long-term rate of growth of that investment, compounding growth, then, yes, after a certain period of time, thanks to the magic of compounding, that eventually

that bucket of money will grow to a million dollars. There's a very crude back-of-the-envelope calculation that a lot of people use. It's called the Rule of 72. And the Rule of 72 states that in order to estimate how long it will take for a given amount of money to double in value, divide the annual rate of return into 72. So in other words, the annual rate of return multiplied by the number of years it will take to double in value equals 72. So if something compounds at an 8% annualized growth rate, it'll take nine years to double. If something compounds at a 7% annual growth rate, it'll take 10.2 years to double. And I throw that out there because it's an easy way to do some quick mental math. You know that if you have $250,000 invested, it doubles once,

it turns into $500,000, it doubles again. You've got a million. And so based on that rule of 72, if you invest $250,000 and you assume an 8% annualized rate of return, then it will double twice in 18 years. So what you asked about in your question, you said, you know, if a person hypothetically were to invest money between the ages of 18 to 25, well, I don't know how much money a person at that age will make. But yeah, there are people, certainly actors, entertainers, maybe a small handful of teenage entrepreneurs who make very good money when they're in their teens. So just as a purely hypothetical thought experiment, sure, if you were to take that seven-year period and you were to save $35,700 per year over the span of seven years, then after seven years you would

have saved $250,000. And if you leave that alone and let it double twice over the span of 18 years, assuming an 8% annualized interest rate, and not factoring for any fees or taxes, then after 18 years, you'd hit your million, even without contributing a single penny again. So now that we've walked through that as a thought exercise, let's think about how that can apply to you. There's a tool that I want to refer you to, and it's called the CNN Millionaire Calculator. We will put a link to this calculator in our show notes, and our show notes are available at afford anything.com slash episode 286. Now, this calculator, as the name states, calculates how long it would take you to save a million dollars, become a millionaire.

Now, Alex, in your case, I'm going to go to this calculator. I'm going to input that you are 25 years old and you are starting with zero. And I'm going to put that into the section of the calculator that assumes that you're putting this money in tax deferred accounts. So how much you currently have in tax deferred accounts, I'm putting in zero. And then the next question is, how much will you save? And so just hypothetically, let's imagine what would happen if you were to save the absolute maximum amount in your 401K and a a tax-deferred IRA and the individual maximum contribution to an HSA. As of the year 2020, you're allowed to contribute $19,500 to your 401K, $6,000 to an IRA,

and $3,550 to an HSA, which is a total of $29,050. Obviously, this is probably unrealistic and too extreme. You're at a job where you're making $50,000. you most likely aren't going to be able to save $29,000. Maybe. I mean, I'm not making any assumptions. There are definitely people who save more than 50% of their pre-tax income. And if you can do that, that is amazing.

More power to you. But I'm just saying not to beat yourself up if you don't. If you think you can, sweet. But remember, no shame and not. Like nobody's expecting you to. So anyway, with that disclaimer. Let's just assume, hypothetically, that you were to save $29,050, just so we know what the upper end of this possible range is.

Under that set of assumptions, 25 years old, starting with nothing, saving $29,050 into a tax-deferred account per year with an average annual gain of 8%. According to this calculator, you would become a millionaire in 17 years. Now, there are a few flaws with this. First of all, you probably will not be making your current salary for the next 17 years. You will, most likely, have raises along the way. And if you contribute a portion of those raises into additional investments, even if those are investments in taxable accounts or if those are other types of investments in other asset classes, such as real estate, as you continue to earn more money and as you continue to invest, that can shorten the time

horizon. Fidelity.com has some excellent calculators that you can play with. We will link to those in the show notes as well. And the blog Financial Mentor also has some very good retirement calculators. So we'll link to all of those in the show notes. And Alex, I would encourage you to play with a whole bunch of different retirement calculators because each one, millionaire calculators or retirement calculators, either one, because each one uses a different set of assumptions and allows you different levels of specificity or generality, different levels of iteration. So I find it helpful to use multiple calculators since the output that you receive, the answer that you receive will be a reflection of how many assumptions you're able to put into the

calculators, you know, what goes in is what comes out. And since nearly every calculator has its pros and cons, it's been. and its limitations, I find that by using an assortment of different calculators, I'm able to get a broader, wider, more robust range of possibilities. The other benefit of using multiple calculators is that it serves as a reminder not to confuse precision with accuracy. Sometimes when you put a bunch of numbers into a spreadsheet or you input a bunch of variables into a calculator, it creates an output that is so unduly precise that it becomes tempting to conflate precision or specificity with accuracy.

But any calculator or spreadsheet can offer an output that is specific yet wildly off. And while cognitively we may know that, emotionally it can be tempting to seek the certainty of a very specific number. And that's, I think, another benefit, a psychological benefit of using a lot of different calculators in order to get a range of possibilities. So that is my answer to your first question. Now, as to your second question, you asked about calculating a phi date and figuring out what your expenses are going to be.

Again, in the spirit of not confusing precision with accuracy, many people calculate their phi date as a multiple of their current spending. So if Bob and Bridget Smith currently spend $60,000 a year, well, they multiply that $60,000 by 25 and use that as their phi number. The issue with that is that over the span of a person's lifetime, they're spending changes wildly. The expenses that you have at a given point in time, if you were to put it all on a graph and graph out your expenses throughout your life, the expenses that you have at any given point in time are a random point on that graph of your life. And so to over-emphasize that one random point in time does not make a lot of sense to me,

because the reality is there is no way to predict what your expenses are going to be in the future. There is no way to know, will you be single? Will you be married? Will you be married and then divorced or widowed? Will you get remarried? Will you have zero children? One child, two, three, four, eight? Will any of them have special needs? Will yourself? Your self? or your spouse have an accident or injury that results in a disability? Will anyone come down with some chronic pain? Do you have family that lives overseas? Will they need money?

Or will you need to go visit them and take care of them for a while? Will you get sued? Will you be in a car accident or a natural disaster or have some other major home catastrophe that insurance doesn't cover? Will you, 10 years into the future or 20 years into the future, experience a major change in your religious faith that impacts the priority that you give to tithing? Will you or someone in your family experience trauma or addiction and need to pay for mental

health services or residential rehab? I mean, I think you get my point. There is no way to predict what life has in store. And as a result, there's no way to predict what our expenses are. It's very tempting to think that you can control all of your expenses in the future as long as your life remains exactly the same. because if life doesn't change, then sure, you can continue to make certain consumer changes or develop certain consumer habits that limit your spending.

But spending is not simply a function of choosing not to go to a restaurant or choosing not to get fancy haircuts. That's the talking point that people like to emphasize because it's within our control. and our desire for a sense of control and autonomy over our finances makes it much more pleasant to read an article that says, hey, dye your hair at home, don't go to a salon. That is a very palatable message compared to a message that says, hey, your sister might end up unemployed for eight months with a serious drug addiction and you're going to have to help her out. or hey, you know your anxiety that you've been managing, self-managing for a while,

it's going to get worse and you're going to need help. And your insurance isn't going to cover it and it's not going to be cheap. Those are the things that we don't like to hear, but that's the reality of life. So do I believe in a fine number in the strictest, most literal sense of the word? Do I believe in an interpretation of a fine number in which you can predict with completely, accuracy, what your expenses will be over the span of decades? Not at all. But do I believe in a fine number, if it is interpreted through the benchmark of here's how this number compares to the average household income in the United States. And here is a number that will provide me

with a safety net and will provide me with greater options and greater flexibility. such that if an emergency really does take place, things might still be tough, but at least I've got that. And that's going to provide a solid foundation. That's the level of FI number that I believe in, the safety net, the foundation, the giving you a base to build from. And so to answer your question about how to calculate a FI number and then by extension of FI date, I would ask what is your distinction between needs and wants, at least at this point in your life, and what is your definition of enough, at least at this point in your life? I would start there because a fine number, when it is enough, is a pretty darn good place to start,

a number that will cover your needs, not necessarily your wants, but your needs, and a number that will provide enough of a foundation is a good starting point. But bear in mind that even the definition of enough is going to change as in the future your family changes. You might get married, you might not, you might be married for a time. You and your spouse might live in the United States, or depending on who you're with, you might end up in Antarctica. I mean, anything could happen.

It makes sense that people do benchmark the phi number to right now because right now is all we know. During the interview with Morgan Housel on this podcast, it was a few episodes ago, Morgan Housel talked about strong opinions held weekly or strong views held weekly. And that is what a good FI number should be. It's a strong view in that it's motivational and you work towards it and it gives you this sense of freedom. but it's also held weakly like sand in your hand. If you grasp onto it too tight, it'll fall through your fingers. But if you hold it loosely, you hold it weakly, it exists in this moment for as long as it can.

And then the moment changes. And the numbers change along with it. That is probably far more of a philosophical answer than what you were looking for. but I can't just say like, well, then the date is 2024. That's, you know, that just wouldn't be an honest answer. So thank you, Alex, for asking that question. And again, congratulations on graduating from grad school, on being debt-free, on having an emergency fund, and on starting to build towards FI.

We'll come back to the show in just a second. But first, our next question comes from an anonymous caller in Austin, Texas. and since I give every anonymous caller a name, all right, Anonymous, Austin, so I'm feeling the letter A here. So we'll go with Amy. Amy from Austin. This is Anonymous in Austin, Texas. First, I would like to thank you for sharing all of your knowledge

in such a way that is easy for anyone to understand. My husband and I purchased our first home in 2016. We had no experience, no guidance, and unfortunately had a realtor with little experience. as well. Our home is right outside of Austin, Texas, and when we purchased it, we knew it would not be our forever home. However, we did not know what to look for in an investment property. We discovered your podcast in the fire community in the fall of 2018. In late 2018, my husband and I decided to start our path to FI and reduce our expenses and cost of living. Here is a bit of background leading up to my

questions. Since then, we have paid off all of our debt, excluding our mortgage, and saved up six months of expenses in our emergency fund. We also have a separate savings account where we have saved up for a down payment for a rental property. This year, we turned 32 and have started maxing out our retirement accounts through work and started contributing to our Roth IRAs for the first time ever, and we are contributing the max amount as well. Our house house, This isn't a very good neighborhood, but certainly does not meet the 1% rule. We live below our means, and now that we have been able to reach some of our goals, we want to look into reducing our cost of living next. The Austin area cost of living is pretty high. We purchased our three-bed,

two-bath home for $295,000. We are trying to decide if we should move to a cheaper home around the 200,000 range, and rent this home for about 0.6% of its total value in monthly rent, and hold on to it for a few years to sell out a better profit. Our home is now valued at 310,000. Another option we thought about is if we should stay in this house and try paying off the mortgage quicker and putting our savings down for a rental property. Ultimately, our goal is to reach FI through investment, accounts and rental properties. We do not have any rentals now, and purchasing a cheaper home for us to live in, would delay us a bit while we save up again for a down payment on a rental. We would have our current home to rent, but this house will not rent at 1%. And lastly, there is also the option of

selling this home. However, there continues to be more development around the area, which has increased the value of the property. Any insight is greatly appreciated. Thank you for all the great work you do, all of your guidance, and for encouraging others to stick to their plans. Amy, thank you so much for asking that question. And congratulations on everything that you've done, on starting the path to FI in 2018, on cutting your expenses, on paying off your debt, on building a six-month emergency fund. You've done so many awesome things. So big congratulations on all of that.

Now let's talk about your question. and let me start by saying that when it comes to the 1% rule, and I was just saying this on a Zoom hangout last night with some of the people from this audience, when it comes to the 1% rule, I know a lot of people learned it from me, but it has, there are moments when I look around and I go, oh, wow, I've created a monster, because there are many times in which the 1% rule is applied to situations that it was not designed to be applied to. So let's stop and define what the 1% rule is and when it should be used. So the 1% rule, for people, I know anonymous in Austin, I know that you know this, but for the sake of anybody who is maybe

tuning into this podcast for the very first time and has never heard of it, the 1% rule is a broad, generalized rule of thumb that states that when you are searching for a rental property to purchase, you want to set your search criteria. such that you're looking for properties in which the gross monthly rent is at least one percent of the purchase price. So for every $100,000 worth of home, that property should rent for $1,000 a month. $200,000 home should rent for $2,000 a month. Now, the reason that I emphasize the word search in that description twice is because the 1% rule of thumb is meant purely as a search criteria. Once you already own the home, throw the 1% rule out the window. It no longer applies.

And the reason for that is twofold. Number one, the purpose of the 1% rule is that when you begin the search for a rental property, you need some type of filtering mechanism. There are millions of properties out there. And you need some crude, blunt force instrument that will help you narrow down the millions of properties that are out there on the market down to a manageable size, even if you narrow your geographic area, you know that you want to invest only in the 45224 zip code, there are still a lot of properties there. And so in order to perform due diligence on the properties that are out there, I mean, you cannot realistically perform due diligence on 200 properties. It's just, it's more, even if you hired people to help you,

that's, you would need a huge team for that. That's more than any person or even any team of people could reasonably do. And so that initial sorting mechanism, the 1% rule, allows you to cut that basket of properties down to five or 10 properties that you can then look at with greater scrutiny. That's the purpose of the rule. And as I said, the reasons we're two-fold, right? So one of those reasons is the purpose. And once you already own a home, then that purpose no longer applies. The reason that the 1% rule exists is to be a filtering mechanism, but once you already own the home, you no longer need a filtering mechanism. And therefore, it is a misapplication of the rule because the purpose of the rule doesn't serve

the situation that you're in. So that is one of the two reasons. The second reason is to think not about the rule, but rather about what the rule represents. Now, the reason that that rule serves as a filtering mechanism in the first place is because it is a crude blunt force instrument to represent properties that give you a reasonable probability of getting good returns. If a property rents for 1% of its gross value per month, well, that's 12% gross per year, and using a different very crude blunt force rule of thumb called the 50% rule, there's a rough estimate that operating overhead will consume 50% of gross, which means that if you're collecting 12% gross per year and half of that goes towards operating expenses, such as property taxes,

insurance, management, repairs, maintenance, etc., then the remaining 50% would be net operating income. And so as a filtering or sorting mechanism, if you are trying to limit your search to properties that have a reasonable probability of giving you a decent net operating income, you know, 50% of 12%, that's a 6% unleveraged cap rate, right? If you're looking across a broad spectrum of properties for what gives you a decent likelihood of getting that, then great. the 1% rule can help you filter through. But again, if you look at what the 1% rule represents, ultimately it is a formula that is supposed to help you find a property that has a reasonable probability of giving you a good

cap rate. And so once you already own a home, you don't need the 1% rule. You need cap rate. Because ultimately the 1% rule is simply a shortcut to finding narrowing down. to a basket of properties that are likely to give you a good cap rate. But ultimately, whether or not something meets the 1% rule is irrelevant, what matters is, does it give you a good cap rate? And so, for example, if the operating overhead is significantly less than 50%, let's say that you have operating overhead that is 35% of gross. And remember, operating

overhead does not include financing or debt servicing costs. It does not include the P&I portion of a PITI mortgage, if your operating overhead is significantly less than 50%, well, guess what? All right, that's another way that you can get a good cap rate without having a property meet the 1% rule. If you already own a property and you know how to create greater efficiencies within the operation of that property, all right, again, that can contribute to that net operating income, which gives you a better cap rate. And so that is what actually matters.

At the end of the day, your bank account is not going to care about whether or not a property hits the 1% rule, your bank account will be a reflection of the cap rate that you receive. So, everybody who's listening to this, because I know I'm the person who's been a vocal proponent of the 1% rule during the search process, and it has gotten misapplied and gotten thrown out of whack. So please, everybody who's listening to this who is interested in real estate investing, raise your right hand and repeat after me, I pledge not to think about the 1% rule for the properties I already own. So Anonymous in Austin, or I guess we're calling you Amy, Amy and Austin.

You mentioned that if you were to rent out your current home, it would rent for about 0.6% of its current value, and its current value you said is about $310,000. So I'm assuming that what you meant is that if you were to rent out your current home, the monthly rent would be $1860, $1,160 per month. All right, great. Now, starting with that, grab a spray. spreadsheet that helps you calculate cap rate and plug in the numbers. So 1860 a month, assuming perfect occupancy, assuming no vacancy, that gives you $22,320 a year in potential gross rent. Next,

you want to subtract out a reasonable vacancy estimate that's going to depend on your area, 5%, 8%. That's going to be very area specifics, but subtract out a vacancy estimate. add in any other income that you might collect, such as pet fees, if there's maybe a separate storage shed on site and you want to charge an additional fee to the people who want to use a storage shed, anything like that, parking fees, laundry fees, any other income in addition to the regular monthly rent, add that in and then start subtracting out the operating expenses. So, as I mentioned, repairs, maintenance, capex, management, property taxes, insurance, what are those? And the benefit of doing this exercise with a property that you already own is that you have a really good grasp on those numbers.

Like, that is a benefit that you have that people who don't own the property yet don't have. It's very hard to estimate operating expenses when you're purely just estimating when you're guessing because you haven't owned the property. and the current owner, the seller, may or may not be willing to provide you with the last years' worth of utility bills. But in a case like yours where you already own the property, you know what the past few years worth of utility bills have been. You know what the past few years' worth of trash, sewer, property taxes. Like, you have all of that information.

You know what the homeowner's insurance costs. So you can make a pretty accurate estimate of the ongoing. operating costs of this property, which means you can then figure out what that net operating income is. And that net operating income divided by the purchase price of the property, that $2.95, well, that is an expression of the cap rate. And the cap rate is, fundamentally, it's the unleveraged dividend. So whatever number you arrive at, that number expressed as a percentage is essentially the dividend payment, the unleveraged dividend payment, that that property is giving you.

And so if you imagine that property as analogous to a stock, you know, a stock or any asset grows its value in two ways. There's capital appreciation, which is the rise in value of the asset itself, and then there's the dividend or the income stream that it pays out. So if that cap rate that you calculate is analogous to the dividend and the appreciation, which is, of course, going to be a projection, there's no way to know that for sure. but if the projected appreciation of the property, if dividend plus appreciation equals awesome return, then great.

Ultimately, that's what matters. The 1% rule doesn't matter at all. The 1% rule is simply a filtering mechanism to help you narrow down to a basket of properties that gives you a greater probability of having a good return. But once you've already narrowed down, once you have that one specific property, then what matters is that return or that projected return. And unleveraged dividend plus appreciation equals total return, total unleveraged return. That's the math that I would do if I were in your shoes. Figure out what kind of return you expect to get from this property.

And once you have that number, then you'll have a pretty clear sense of whether or not you want to move to a different property and rent this property out. The other thing that I wanted to say is that the benefit to the strategy that you suggested, buying a cheaper house, moving into that cheaper house, and renting out this one that you currently own, is that if you were to do that, you could buy that second house, that cheaper house, with a primary residence mortgage. And a primary residence mortgage is going to give you the lowest down payment requirements and the lowest interest rate that you could get from an institutional loan as compared with if you were to try to take out a second home loan or an investor loan. And so the benefit of getting that primary residence mortgage is really worth moving for a lot of people.

And the fact that you want to move anyway, the fact that you want to reduce your personal out-of-cost living expenses, added to the fact that you then have the advantage of owning two homes, both of which have a primary residence mortgage, which is way better than having a home with an investor loan. I mean, that's interest rate icing on the cake there. So that's the direction that I would be moving in if I were in your shoes. But thank you for calling in with that question. I think that you have some great options in front of you. And congratulations again on everything that you've done, on reducing your expenses, on being on the FI path for years, on paying off your debt, on having an emergency fund, on doing so many things that build really good financial health.

So congratulations again and best of luck. Our final question today comes from Jen. Hi there. I'm just curious to know if you have any case studies or recommend any blogs on how to do the type of real estate investing that you're mentioning in Canada. The real estate prices seem to be substantially higher than the U.S. And so I'm just curious if you have case studies of Canadians buying properties in Canada. or buying them in the U.S. and being able to have them cash flow. Thanks so much. Jen, thank you for calling and asking that question.

So I'll take the question in two parts. Canadians buying real estate in Canada and Canadians buying real estate in the United States. Now, in the course that I teach, your first rental property, I know that we have students who are Canadian who are interested in buying rental properties in the United States. I am not aware of anyone. I might be wrong. I mean, we have more than a thousand students,

so I certainly don't know every person's intentions. But the Canadian students that we have, to the best of my knowledge, are buying rental properties in the U.S. With that said, what I would encourage you to do is talk to the community. Go to afford anything.com slash community. It's free. And we have a village of people, a pod of people in that community who are Canadian. Present this question to them.

That's what the community is for. And certainly the Canadians within our community are going to be the best people to point you to resources that are Canada-specific. In both the community and in the course, we have pods of people who organize around geographic areas. So if you go to the forums for either of those, you'll find forum threads and chats among people who all live in any given shared location. The two communities sort of organize a little bit differently. In the community, the afford anything.com slash community, we tend to have people who organize based around where they currently live. So we'll have people who organize based around the fact that they all are currently living in the Pacific Northwest or in, Florida or in Boston or in Canada. In the course community that we have, it's a little bit

different because there people organize based not around where they live, but where they want to invest. And so we have these pods of people and these forum threads that are based around people who want to invest in Indianapolis or Atlanta or Detroit. And they may not necessarily live there, but those are the places that they are looking at. And so, So they talk to other people who are either currently investing there or who are also looking at investing there. And some of those people may be local and some of them may not be. But those are the kind of separate ways that these two communities have organized.

One organizes based on investment location interest and the other organizes based on current geographical location. But there's a lot of crossover between the communities. So I would imagine that if you talk to the people, just go to over. for-or-it-anything.com slash community. It's free. And if you talk to the people there in the Canada community, I'm sure that they can point you to some resources related to being a real estate investor who's based in Canada. The one other recommendation that I would give in terms of content creators is that there's this award. It's called the Plutus Awards. And they are industry awards for

people who create digital media around personal finance, personal finance bloggers, podcasters, YouTubers. They have been giving awards for 10 or 11 years now, I think 11 years. Every year or almost every year, they have always given an award to the creator who is making the best Canadian content. And so if you go to plutusawards.com slash winners, and we will put a link to this in the show notes, you can search through the winners of best personal finance material for Canadians. You can search through a decade worth of winners in that category in order to be tapped into

other bloggers, podcasters, YouTubers who specifically cover that topic. So that's a really good resource for learning more. Thank you for asking that question, Jen. And best of luck as you discover more Canada-specific information. That is our show for today. Thank you for being part of this community. My name is Paula Pan. This is the Afford Anything podcast.

catch you in the next episode.