Afford Anything - Ask Paula - Should I Invest $5,500 in One Huge Chunk? - and More Investing Questions

Episode Date: October 3, 2016

#45: Podcast listener Eva is interested in opening a Vanguard account. She noticed that people need $50,000 to access their personal advisor services. It’ll take her several years before she can access this. What should she do in the meantime? Amy, another podcast listener, wants to invest $5,500 into her Roth IRA in 2017. Should she invest the full amount on January 1, or should she spread this throughout the year? ...and more can be found at https://affordanything.com/45-ask-paula-invest-5500-one-huge-chunk-investing-questions/ Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. And that's true not just for your money, but also your time, energy, focus, attention, any limited resource in your life. What do you want in life? And how are you going to use those limited resources in order to get there? My name is Paula Pan, host of the Afford Anything podcast, the show dedicated to answering those questions. Today is the first Monday of the month, which means it's tied. for our monthly Ask Paula episode when I answer questions submitted by you, the listeners. Today's first question comes from Eva.

Hi, Paula. I'm interested in opening a Vanguard account, and I've heard you and Jay Money talk about that before. After doing some research on their website, I read that in order to access their personal advisor services, that you would need at least $50,000. And since I'm just starting out, my plan is to open a Roth IRA and contribute the maximum amount. But I was just wondering if you had any advice on how I should go about that or any advice on how I should proceed until I am able to get to that point. Thank you. Eva, the question that I would ask you is, why are you interested in getting a personal advisor? Specifically, what do you hope to achieve by having a personal advisor?

Now, I don't know what your answer to that question is, but there are two common answers that I often hear. Some people want a personal advisor because they're trying to obtain more information. They're trying to get more education. So they want answers to basic questions like, how much money should I be saving? Am I on track? What are the pros and cons of different types of asset classes? All of that is lumped under the broad category of education. The second reason that people often want advisors is because they want personalized information that is custom tailored to their unique circumstances.

You know, your portfolio, your age, your risk tolerance, your goals and interests and the things that you want to achieve with your investments. The answers to those questions often can't be found in mass market educational information. And that's often the second reason why people want personal advisors. So given that you at this point cannot access Vanguard's personal advisor services, how else can you achieve that same goal? Well, if the reason that you want a personal advisor is for the educational aspect, then I would recommend books, blogs, podcasts. A few of my favorites, and I will link to all of these in the show notes at podcast. afford anything.com. But a few of my favorites include Oblivious Investor by Mike Piper. That's a website that is excellent for anybody who is new to the world of stocks, bonds, index funds,

ETFs. It's a great resource to learn about market investing. Another favorite website, and this one is much more advanced, but it's written by an advisor named Michael Kitsis. It's a website called Kitsis.com. Again, I'll link to this in the show notes. I also recommend on my own website at Afford Anything.com a blog post that I wrote called I don't know how to start investing and I'm afraid of making expensive mistakes. That's another excellent article that you could read if you want more education. There are also many books that you can read. Among my favorites, Jim Collins, who was interviewed on a previous episode of this podcast, he just released a book called The Simple Path to Wealth. Mike Piper, the blogger behind Oblivious Investor. He also has several books that are for sale on Amazon. So that's what I would recommend if your goal in having a personal advisor is the educational component. What if it's not? What if your goal in having a personal advisor is to get that unique information, recommendations that are custom tailored to you that you could not find anywhere else? Well,

Some people might say that you could get that by going to a robo-advisor. Robo-advisors are websites such as Wealthfront, Betterment, Gemstep. These are websites in which you input all of your data, you tie them to your investment accounts. They scan those accounts, and then they have an algorithm that spits out some recommendations for you. We talked about Robo Advisors at length on episode 24 of this podcast, which I will also link to in the show. notes. Robo advisors have their pros and cons. And depending on what your goals are, maybe that will be sufficient for you. Maybe not. If it is great. If not, you can always hire a human advisor. That's always an option. Now, one thing that I would emphasize if you do that is that this

human advisor must have a fiduciary duty to you. The key. The key. The keywords here are fiduciary duty. So before you pay anyone to give you advice, the first question that I want you to ask that person is, do you have a fiduciary duty to me? Or do you have a fiduciary obligation? Those are both different ways of saying the same thing. If they say yes, proceed with the conversation. You can consider them for the work that you need. But if they say no, if they do, not have a fiduciary obligation, then I would recommend that you not enlist them to give you advice. A person who does not have a fiduciary duty to you might recommend an insurance plan or a mutual fund that pays them a bigger commission. Now, they won't, quote, unquote, lead you astray entirely, at least legally they're not supposed to. But they're not required. But they're not required to give you the best advice that's in your own interest. In other words, people without a fiduciary duty are allowed, are legally allowed to consider the compensation that they receive

from, you know, the kickback from the insurance company, the kickback from the mutual fund. They're legally allowed to consider that before they make a recommendation. However, people who have a fiduciary duty to you by law that cannot influence them. They have to give you advice that in your own best interest, even if that results in financial detriment to them. So thank you for asking that question. I hope that helped. Our next question comes from Amy. Hey, Paula, this is Amy from Minneapolis.

I love you. I think you're super awesome and I've learned a ton from you. My question is regarding the Roth IRA contributions. So I think I've heard you say that you dump in your max right in jails. January. And I feel like I've also heard guests say that the regular contributions say dividing that 5500 by 12 and just automatically depositing those on the first of the month might be a better option. Can you just discuss the different benefits of each and which might be a good plan? Thank you so much. I can't wait to hear your response. Bye.

Ooh, okay, I get really excited about this topic, so I'm glad you asked. All right. Essentially, your question is about dollar cost averaging. Assuming that you have $5,500 sitting in cash on January 1st, is it better to put that entire $5,500 into the market today, January 1st, or is it better to pace it out over the span of a year? Now, for listeners who aren't acquainted with the term dollar cost averaging, here's what that term means. Dollar cost averaging is the act of slowly investing into the market over a prolonged period of time. So, for example, instead of putting $5,500 into the market all at once, you would put $458 and 33 into the market per month every month over the course of 12 months.

So at the end of a year, both people have contributed $5,500 in total, but one person has done it as a lump sum and the other person has done it every month regularly over the course of a year. And the advantage to dollar cost averaging is that you buy in regardless of what the market is doing. So if you're putting $458 into the market each month, then during months when the market is cheap, i.e. when the market is down, you naturally are going to buy more. Your money goes further. And likewise, during months when the market is expensive, you naturally are going to buy less. The 458 doesn't buy as many shares. So proponents of dollar cost averaging state that this is a way to achieve two goals.

Number one, it's a way to force yourself to stay in the market regardless of its short-term volatility. and number two, it's a way to take advantage of those dips by buying more shares when prices are low, because naturally your money's going to go further when prices are low. Here is where the interesting twist comes in. If you have money up front, Amy, it's better to put all of your money into the market in one big lump sum than it is to hold on to that money and slowly. meter it into the market over the course of a year. Now, this might sound really counterintuitive, but the historical market record actually bears this out. In 1993, two researchers from Dayton, Ohio imagined what might happen if they converted $120,000 from Treasury bills into an S&P 500 index

fund. So in other words, they imagined what might happen if they put $120,000 into an index fund that tracked the overall S&P 500. And they ran two different scenarios. What would happen if they put the whole lump sum into the market on January 1st? And what would happen if they put in $10,000 per month over the span of a year? So they ran these two scenarios and then they ran a historic analysis of what would have happened covering every year from 1926 to 1991. The lump sum investing strategy won.

two-thirds of the time. So based on historical evidence, the odds strongly favor investing the lump sum immediately. They were not the only researchers who came to this conclusion. The following year, another pair of researchers ran a similar analysis and came to a similar conclusion. And about a year later, yet a different research team actually demonstrated that there is no statistically significant difference between dollar cost averaging into the market and throwing money into the market at random intervals. In December 2001, a group of researchers then started asking the question, okay, okay, okay, at this point, research has demonstrated that dollar cost averaging does not help you gain more, but could it help you lose?

less. So they ran an analysis, a historic analysis, trying to see if dollar cost averaging is a better risk mitigation technique. And they also explain that the answer is no. In their report, they stated that loss aversion still does not explain the existence of dollar cost averaging. So study after study after study has shown that it is better historically to invest a lump sum than that. is to dollar cost average. Now, why? Isn't this counterintuitive? I mean, doesn't this fly in the face of not just everything that we've learned but also

common sense? It might seem that way. But the reason actually ties back to asset allocation. One of the reasons that it is historically better to invest a large lump sum is because during the year that you're slowly metering that money out, you're hard. whole asset allocation is out of whack. It's not where you want it to be. Dollar cost averaging is great if you don't have the money up front. It's a great way to invest new money because, frankly, you can't invest money that you haven't earned yet. So when you get each paycheck,

dollar cost averaging is a great strategy for investing that new money that flows in with each paycheck because there was no possibility of you putting that in the market before. But if you have the opportunity to put it in the market earlier, then do so because A, your asset allocation will be in line with where you want it to be. And B, the market often moves in big leaps. There are often just a few days of a given year when it makes its big gains or its big losses. And as the historical record shows, two-thirds of the time you are better off exposing your money, to the market as early as you can. So, Amy, thank you so much for asking that question. That is a passionate topic of mine. So I'm really excited to have the chance to talk about it. I wrote a blog

post a long time ago about dollar cost averaging, about this exact question, and we will link to that in the show notes as well. There are two more questions that I'm going to answer in this podcast, and both of these questions relate to real estate investing. So if you're not interested in real estate you can drop off right now and I'll see you in the next episode. Before we get to these next two questions, I'd like to take a moment to thank our sponsor. Have you ever wanted to talk to a financial advisor just to ask like one question, maybe two? Well, guess what? NerdWallet has this cool new app that lets you have one-on-one conversations with financial advisors and it's available at no cost to you. You can chat with an advisor about anything

related to money, such as retirement, investing, insurance, debt, all things money related. And you'll get personalized one-on-one advice. Check it out at no cost to you by going to nerd. dot me slash Paula. That's nerd. dot me slash Paula, P-A-U-L-A. Now with that said, let's hear the next question, which is from Daniel. Hey, Paula, this is Daniel.

I'm from the southeast part of the United States. I had a question about initially screening for homes. I often look on Zillow just because it's easy. People are always posting things on there, and it's fun for me to check things out. But I realize that because it is so easy, so many people are looking on there, that these are probably not the best deals.

It's probably some of the worst, actually, because it is so competitive. So I was wondering what perhaps are some good websites to use or other sources to use just for initially screening homes to find maybe a list of some that could be interesting from an investment perspective. Secondly, I wanted to ask about, you know, if I see something online that's, say, a $70,000 duplex that is currently renting gross rent for $1,200 a month, obviously, you know, that on its face seems like a great investment because it's far past the 1% rule.

However, if it's a duplex, I assume it's probably owned by an investor. If it's an investor, they're probably savvy and realize that something is wrong with the home. That's what I would assume. And I was wondering what your take is on that and maybe what are some of the best ways to figure out if something is perhaps wrong from home from first look or from further inspection or whatever. Thanks. Bye. Hey, Daniel. All right.

So you've got two questions. I'm going to start with the first one, which is where do you look for? properties. First of all, you are correct. Zillow is the worst place to look. The thing is, unfortunately, a lot of people turn to Zillow when they're looking for investment properties because that's the tool that they use when they're looking for their own personal residence. But, for lack of a better term, an amateur and a professional, or in this case a regular home buyer and a investor do not use the same tools. And that's true of any industry. So think about photography. An amateur photographer, you or me, I'm assuming you're not a professional photographer,

an amateur photographer is not going to use the same tools that a professional photographer would. An amateur cook is not going to use the same tools that a professional chef would. An amateur driver, a person who just normally drives a car, is not going to use the same type of vehicle that a professional race car driver would. So in every industry, people who take photos for themselves, cook for themselves, drive cars for themselves, don't use the same tools that people who do this in order to make money use. And the same is true when you're looking for properties. So unfortunately, all across my blog in like the comment stream of almost every article, there's always at least one person who's like, I spent like an hour on Zillow and I couldn't find anything. There's

absolutely nothing good in my town. And I'm like, wow, really? You've spent an hour on Zillow. You don't even know what you're doing. Okay. So if Zillow, and I'm not picking on Zillow specifically, this is true of Redfin, Trulia, any of those public facing websites. Those public facing sites, most of them draw data from the MLS. The MLS is called, is stands for the multiple listing service, and it is the platform that real estate agents and brokers use when they are listing properties that are for sale or for rent. And so all of these public-facing websites, Zillow, Trulia, Redfin, they pull data from the MLS, often 24 to 48 hours later after that data is listed. And that's what you're seeing. You're seeing a secondary MLS website that

is designed to be consumer-facing. But as you've said, that's where the vast majority of people are. That's where the competition is. And that is where retail buyers tend to hang out. Anytime that you are trying to buy something wholesale, you're not going to hang out in the same zones as people who want to buy something retail. So what are some of the tactics

that investors use when they're looking for properties? First, many investors look for properties that are in pre-foreclosure. So a little bit of background. If a homeowner defaults on their mortgage payments, then the lender can file a public default notice, which is known as a notice of default. And this alerts the borrower that there has been a breach of an agreement. And when the borrower receives this, they have a grace period in which they can reinstate their loan by paying off the outstanding overdue balance and getting caught up with their payments. So this grace period is known as pre-foreclosure. In most places, this is public data. And so many investors will look for

properties that are in pre-foreclosure and contact those homeowners directly with an offer to buy that property because the homeowner doesn't want to get foreclosed on, but they may be underwater on their mortgage. Otherwise, they would have probably just tried to list it. So oftentimes, the homeowner might list the property for short sale or the homeowner might get contacted by an investor who makes a private deal directly kind of person to person. So doing that public record search, looking for pre-foreclosure properties, that is one of many ways that you can find good investment properties. Another option, so that's one option, right? You do the public record search. You look for pre-foreclosures. Another option is to form relationships with people who work. with homeowners who are currently in pre-foreclosure.

So, for example, real estate agents who specialize in short sales, that's another great source of leads. In order to find them, check out the Short Sale and Foreclosure Resource Directory, which is offered by the National Association of Realtors. That is an optional certification program that some real estate agents opt into. And so that's an indicator that those agents specialize in short sales and foreclosures know what's on the area and can often clue you into deals that are coming up, deals that have been under contract, but that have just fallen out, things like that. So those direct relationships with short sale and foreclosure specialists, that's tactic number two. Tactic number three, auctions. So there are two

kind of main categories of real estate auctions. There are voluntary auctions in which an owner or an owner's representative uses a public auction as a way to sell their own property. And then there are mandated auctions in which an outside third party that does not represent the owner's interests, typically either a bank or a municipality, claims the property as collateral against a debt and then puts that property up on auction asking the court to force a sale. Court mandated auctions are also known as trustee sales. So that's tactic number three, is to look at different types of auctions in order to find those properties. And we, can really go into the weeds with that because rules for tax lien auctions are set by the county

that holds them and that can be very different than foreclosure auctions like the kind that you would find on HubZoo or Bid for Homes or Auction.com. So we can really go into the weeds on those. But long story short, auctions are another great way to look for good investment properties. Another tactic, since your question is about tactics, is driving for dollars. And so driving for dollars is the action of picking. a certain geographic area, such as a neighborhood or a zip code, and driving around and looking for indicators that an owner might be interested in selling their property. So, for example, if a home has a lot of deferred maintenance, such as overgrown lawns, clogged gutters, peeling

paint, that type of deferred maintenance suggests that the homeowner may be in a financial bind. Maybe they're behind on their bills. Maybe they're just not interested in the property. They're going through some type of hardship. And maybe that homeowner, assumes that they're not going to be able to sell their house due to all of those deferred maintenance issues. But that's where you come in and that's where you can, again, have a direct conversation with the homeowner and offer to purchase their property. Now, that's tactic number I've lost count, maybe four, I think, four or five. So tactic number, wherever, whatever count we are right now, is to buy properties from wholesalers.

Now, I don't necessarily always recommend this, but wholesalers, you know, wholesalers make their money by finding properties that would appeal to. investors and they get those properties under contract and then they sell the right to complete that sale. They flip that contract to investors. And that can be a great resource. I mean, you're functionally paying that wholesaler a finder's fee for doing all of the legwork for you. And wholesalers, by definition, specialize in serving investors. Now, they typically tend to serve people who flip rather than buy and hold investors. Regardless, there are often overlaug overlapping circles in the Venn diagram for both of those. So that's another way to look for

investment properties. Postcards are another really good tactic. Postcards are a tactic that wholesalers often use. It's kind of a funnel strategy, right? So you mail postcards, you cast a wide net to properties in a specific area. Maybe you sent postcards to the owners of every multi-unit that is within walking distance to public transit that is also built before 1970 in a given zip code. And you send postcards to all of those owners and then you continually follow up. It's kind of like email marketing except it's snail mail marketing. That's another way that you can find investment properties. Buying properties directly from landlords and property managers. That's another way to do it. Call up a property management company. Let them know

that you're interested in buying a three-bedroom, two-bath, single-family home in a particular zip code, you know that they represent a lot of houses in that zip code. If any of those owners are interested in selling the property, you would like to be first on their list. So forming those relationships with property management companies or with other landlords, that's another way that you can find investment properties. I'm going to cut myself off before this podcast stretches far too long, but long story short, those are all tactics that are much better than Zillow or Redfin or Trulia or any other website when it comes to finding a good investment property. You don't want to be looking at stuff that is positioned for retail buyers.

You want to be looking at non-retail. If you're paying retail, oftentimes in most markets, you might be paying too much. Now, to the second half of your question, why would a person sell a property if it is a good deal? Could be for any number of reasons. I mean, a person might sell a property because they're 80 years old and they want to just retire and be done with everything. A person might sell a property because they're moving to a different country or a different continent. Maybe they're moving to South America to be because that's where the rest of their family lives. Maybe they just married somebody from China and they are moving to China to be with their new spouse and they want to get rid of all of their physical assets in the United States before they do that. Maybe they inherited a property and they aren't

interested in owning property. You know, that was something that their parents were into, but they themselves are not. So they want to get rid of it. So there are many reasons that a person might sell a property that don't necessarily involve, you know, straight dollars and cents. There are many personal reasons why a person might sell a property. So don't let the fact that a property is for sale scare you off. There are many, many good multi-units and single-family homes that are owned by investors that are up for sale. Oh, and by the way, one other reason, particularly in the case of multi-units, it might be that the investor has just decided to trade up. Maybe they own 10 different duplexes, and they've decided to sell all of those so that they can use that money to buy a 250-unit

apartment complex. So if it's a successful investor, the reason that they may be selling might be that that property has done so well that they're now ready to level up into the next kind of order of magnitude. That could be a reason as well. Thank you so much, Daniel, for asking that question. We have one final question, and it comes from Eric. Hi, Paula. I hope you're doing well. Just wanted to tell you that I love your podcast and you're doing a great job. I have two questions, both involving investing in real estate with partners. The first is, can you outline the basic steps for forming an LLC, especially if the LLC involves multiple partners who are not all equal investors. The second is, can you outline the steps for creating a joint bank account for the LLC?

Firstly, if it's even needed at all. And if so, what is the process there? And if there's any need to reference a joint account in the LLC documentation. Thanks for listening. Thanks for buying such great content and keep up the great work. Eric, as to the first part of your question, how do you form an LLC? First of all, I have to be careful when I answer questions like this because I am not a lawyer and this should not be construed as legal advice. I want to be very clear about that.

This is for informational purposes only. Please consult with a lawyer and do not interpret any of this to be in any way legal or professional advice. Now, when you form this LLC, the actual formation is fairly straightforward. you're going to file articles of organization, which is sometimes also referred to as a certificate of organization. That's just the document that you file with the state that says that you guys are an LLC, that you exist. You're going to pay a fee to the state, of course, because nothing exists without doing that. You're going to choose a registered agent, which is officially the person who gets the mail, particularly when it comes to, you know, if a summons is served or something like

that. The registered agent gets the official mail. Then you're also going to create an LLC operating agreement. And this operating agreement, especially because you have partners coming on board, this is where you want to be incredibly thoughtful. So the operating agreement is just going to outline the agreement between you and your partners. It's going to outline everyone's particular percentage interest in the business. It's going to outline each individual's rights and responsibilities. It's going to outline each individual's voting power. It'll talk about how the profits and losses will be shared. The rules for changing rules, the rules for holding meetings, the rules for voting. It's going to outline everything. What happens if one person wants to sell out of their interest?

What happens if one person gets divorced and their spouse gets a portion of, of the LLC within the divorce. Does that spouse get voting rights? What happens if one of the partners becomes so addicted to substances that they are no longer capable of good decision making? Will there be a way in which other members can intervene and take away at the very least that particular member's voting rights, if not force them into a buyout as a whole? That is all of the stuff that your operating agreement is going to cover. So when you form that operating agreement, I'd recommend that you get an attorney who can really walk you through this because this is the analogy that I would use is, you know, this is the quote unquote leaps that you want to have

clear up front because it's much better to hammer out these issues in the beginning when everybody is still friends than it is to try to hammer out these issues five years down the road when somebody is incapacitated and somebody else has just declared bankruptcy and somebody else is going through a very difficult divorce, you know, that is when there's more potential for infighting and where the he said, she said kind of starts popping up. So that's why you want to have a rock-solid operating agreement. But as to your original question, the process for forming an LLC, that's actually incredibly straightforward. The attorney who helps you form an operating agreement will file the paperwork for you, but it's not a complicated process.

As far as opening a bank account, the bank account is not going to be held in the names of any given individuals. The bank account will be held in the LLC's name. So you're going to open a business bank account as an LLC, and then one or more particular individuals will have access to that bank account and you're going to have to decide who has the right to sign a check. Are you going to require that two people sign a check before that check can be valid? Or is there one person who has sole check signing authority? That's stuff that you and all of your partners are going to have to hammer out. The bank would, you know, sign y'all up however you tell them that you want to be signed up. But you guys are going to have to hammer out those issues ahead of time. So thank you so

much, Eric, for asking those questions. If anybody else has a question that they want to send in, please visit afford anything.com slash voicemail. Now, there are some of you who have left questions that I did not have a chance to get to in today's podcast. I will try to get to them in an upcoming episode. But again, to anybody who wants to leave a question, head to afford anything.com slash voicemail. And that's where you can leave a question for the next Ask Paula episode. We air these episodes on the first Monday of every month. If you enjoyed the show, please go to iTunes and leave a review.

Your reviews are instrumental in helping us get new voices on the show, get great interviews, bring more listeners into the fold. So thank you, thank you, thank you so much to everybody who's left to review. If you haven't done so yet, please go to iTunes and leave a review for the Afford Anything podcast. You can find show notes at podcast.offordainthing.com. Thanks for tuning in. I'll see you next week. Would you rather have $500,000 now or a million dollars? in 10 years. And you can't play the whole like, but if I invested the 500,000 at a compounding,

blah, blah, blah, blah. Well, then I have no idea, Paul. That's the only way my brain can calculate things.