Afford Anything - Ask Paula: Should I Sell My Rentals to Buy More Stocks?

Episode Date: October 26, 2022

#409: Liz and her husband are planning to retire in 5 to 10 years. They have rental income properties, but Liz is bored of managing these, and she’s intrigued by the idea of buying stocks at a discount when the market is low. Should she sell her rental properties and use the money to buy stocks instead? Rebecca is a high income earner and thinking about investing in a Roth 401k … but she’s scared of how much she’ll have to pay in taxes. Should she do it anyway? Anonymous made big changes last year: she got a new career AND sold a house! Now she needs help figuring out capital gains and lowering how much she’ll have to pay in taxes … and she won’t have access to her company’s 401K for most of the year. Kyle and his wife are moving into their dream home! What should they do with their current place? Former financial planner Joe Saul-Sehy and I tackle these four questions in today’s episode. Enjoy! P.S. Got a question? Leave it here 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 need to manage. And that opens up two questions. First, what matters most? And second, how do you make decisions that align with your highest priorities? Answering those two questions is a lifetime practice. And that's what this podcast is here to explore and facilitate.

My name is Paula Pant. I'm the host of the Afford Anything podcast. Every other episode, we answer questions that come from you, the community. And my buddy, former financial planner and former Detroit television money guy, Joe Saul Cahy, joins me to answer these questions. What's up, Joe? Why do we add that in this week? Yeah, you know, just I feel like a lot of people don't know that about you. Once upon a time, you were the Detroit TV money dude. I was. For nine years, I was. And it was a great time. You know what's funny? Well, I think it's funny. Your results may vary. But I moved back to Detroit and I thought, oh, I'll go get my old gig back because I still know a bunch of the producers there.

Talk to Tim, the executive producer. He's like, yeah, we have a new news director. I'll start talking to him. And the two years I was there, I did some segments on Detroit TV to help them with their new stuff, but I didn't have my old go back, go on, sit on set with the anchors and chat about money twice a week role that I had before. I moved back to Texarkana. the week I get here, Paula, the week I get here, Tim writes to me and said, hey, we need you back.

We'd like you to come back and be the money man twice a week again. I'm like, I moved away. You moved to Texas. Yeah. I can do it on Skype and guess what the answer? Yeah. We want somebody local. Yeah.

That makes sense. Well, the good news is you get to be on this podcast every other week. That's right. That's right. Stay focused, Joe. Stay focused on the prize. Speaking of this podcast, here's what we're going to talk about today. Ninja. She's a ninja, people.

Right? Look at that transition. Liz and her husband are planning to retire in five to ten years. Liz loves making money from short-term rentals, but she's bored with her long-term rentals. Should she sell those properties before they retire? We're going to tackle that question first, and then we're also going to hear from Anonymous, who got a new career and sold a house and now is trying to figure out how to handle the tax burden, particularly given that she's not going to have access to her company's 401K for most of the year. Kyle and his wife are moving into their dream home, so what should they do with her current place?

And Rebecca is a high-income earner who's thinking about contributing to both a Roth IRA and a Roth 401K, but she's scared of how much she'll have to pay in taxes. Should she do it anyway? We're going to tackle these four questions right now, starting with Liz. Hi, Paula. I am an avid listener of your podcast. Each morning, I get up before work, walk my dog, sip my coffee, and listen to the wisdom that you have to offer. And I have had fantastic results.

Currently, my husband and I own six rental properties, three long term, two short term, and one commercial. My absolute love are the short-term properties. I get great joy by helping people go on vacation. However, the three long-term properties, I don't feel the love. My question is, is now the time to sell property and invest in index funds? Properties are selling at an all-time high. Index funds and all stocks are at an all-time low. is this the time to make the switch and not have to manage my properties?

A little background. My husband is 59 and I am 55. We plan to retire in 5 to 10 years. We bring in roughly 200,000 a year. We have 600,000 in retirement and 150,000 in cash. Looking at our three long-term rentals, one is paid off. The other two have mortgages of approximately $78,000 each. all of our properties more than pay for the monthly mortgage, taxes, and expenses. My question goes back to, though, is now the time to sell the property and invest in an index fund or stocks or use the profits to pay off the other rental property. If we're looking at retiring in the next five to 10 years and these mortgages are 20-year properties, what's the point?

How will we collect that passive income if we're still paying on the mortgage in our retirement? I appreciate your input and I look forward to what you have to say. Liz, thank you so much for being such a dedicated member of the Afford Anything community. I am honored that I could be part of your financial journey and your life journey, so thank you for that.

And thank you for the question. It's a great question. And before we dive into the answer, There are a few things that I want to highlight for the sake of everyone listening. Number one, I want to applaud the fact that you know what you're passionate about and what you're bored with. As you mentioned in your question, you're passionate about short-term rentals. You love doing that. And you're bored with the long-term rentals.

It's not your jam. So despite the fact that your long-term rentals are mathematically sound, they're performing well, their cash flow positive, even with a mortgage on them, despite the numbers, you have the self-awareness and the priority of life to know that if your heart's not in it, your time, your focus, your energy, your attention is better spent elsewhere. And I want to applaud that. In fact, Steve, can we get a round of applause? This is the life piece of money and life. There are far too many financial books. books, blogs, podcasts, financial pieces of mass media that adhere so closely to the numbers that they overlook the bigger question of, what's this all for? What do you want to do? And so I love

that you're starting with that. You're starting with the end in mind. I see a few options in front of you. And let's go through a couple of iterations of what you could do. Now, you mentioned of the three long-term rentals that you want to sell, one is paid off, the other two have mortgages of approximately $78,000 each. I don't know how much equity you have in those, meaning I don't know if you would be able to sell one of the two that has a mortgage and use the proceeds from that to pay off the mortgage on the other one. But let's say that option A is to sell one or two of your long-term rentals and use that money to pay off the mortgage. on the remaining one. Let's say option A, in no particular order, option A is to sell one of the

rentals and use the proceeds to pay off or pay down one of the other ones. We'll call that option A. Option B is to sell two of the rentals and use it to pay off the other one. Option C and D is to do the same things as option A and B, but instead of using the proceeds to pay off the remaining rental, you would instead invest those proceeds. Option E would be a hybrid where you split the money 50-50, pay off or pay down part of it, and use the other part to make market investments. Option F is to sell all of them right now. And we'll say option G is to hold all of them for a little while longer. So as you can see, there are, and I'm sure I'm missing a few other iterations of what you could do. But there are a lot of different branches that this tree could take.

It's funny, Paul, because you're expanding this out. And I have two different answers on my end. And one is the TLDR answer. And the other one is, I think the more exciting answer, which is the thought behind the thinking, which is just to sell them right now. I agree with everything you said. I would just sell them right now, period. You would sell all three right now. I would sell all three immediately. And then that negates the question of, would you then use the proceeds to pay off existing mortgages? Because if all three are sold, there's no longer a need for that. Plenty of income. I think you do that for a whole different reason, Paula, for a few reasons. The first thing is, and I want to be just a little nitpicky, and Liz, please don't roll your

eyes because I know what you mean. But I want to make sure the community understands this. when you say that real estate is at an all-time high, we are near all-time highs, if not at all-time highs. Different markets, real estate's a local game. So there may be local markets that have been higher, but generally speaking, real estate in the United States, at all-time highs. When she said, stocks are at all-time lows. Stocks are nowhere near all-time lows. Stocks were lower in the 70s than they were in the 80s, than in the 80s, than in the 2000s, stocks are still way high when you compare them to, you know, the big run-up that we had in 1999 that ended in this way over-bought market. So she's talking about some metric like price to earning ratios are at all-time highs,

maybe, but stock prices in general are. And by the way, the reason that's important is when you're looking at stocks, you have to realize that over the short run, we're going to face an uncertain future. And when you go in with the feeling that stocks are at all-time lows, you think you're going to win very quickly. And that is not a good mindset to have when you begin investing in stocks. We want to look at long-term and certainly real estate and long-term are phenomenal places. But over the short run, the stock market's a casino. And no matter what the stock market's at today, it can definitely go lower.

And I want to remember that so I invest with the right mindset. Most people, Paula, bail on their plan way too early. And we don't want to bail on a good plan because we expected, well, the market was way down. I thought it was at all-time lows and look at what's happening now. It's going down more. That's fine. We're looking at 10, 15, 20 years out. She's going to be okay moving there.

And that's the only reason I want to bring that up. It sounds nitpicky at first, but I want to bring it up because of the fact that if we give away this idea that we have any idea at all, of what the market's going to do next week, next month, next year. We're a much better investor. We're a much more fundamentally sound investor if we do that. But that said, I default to exactly the same thing you did, Paula, which was this idea that she said doesn't like it. And there's different ways to success with long-term investments.

Our goal with 10 years or longer is to kick inflation's ass, right? If we can beat up an inflation and find something that does it reliably, that's what I want to do. and real estate in all its different iterations, the types that you buy are one way, and then the stock market's the other way. But given all these different ways, I have to default to this.

And you know who really did a great job of painting this picture? And I'd love this, Paul, if you put this in the show notes. A great blogger has been around for a long time, a gentleman named Pete Adney, who people know is Mr. Money Mustache. Pete wrote a fantastic thing at the beginning of this summer, a great blog post where he had a similar question to this. And he pointed out that real estate has a little bit of work that comes with it.

You own individual properties. There is going to be some work that comes with it. And if you don't enjoy it and we default to one premise in our life, which is I want to spend the most time doing the things that I love and enjoy. If you don't enjoy it, why not move that to a passive investment that's going to just follow that beat inflation river over long periods of time and spend your life doing things that you enjoy. Just do what you enjoy. So I guess, Paula, in one of those branches that you talked about, the other one is convert those into short-term rentals because she likes it, right? But I would

definitely convert into short-term rentals or she suggested just putting them in index funds. I would go with the index fund because it's the least activity she's going to need, tracking, following, working on her investments. Press the easy button, do the things that she loves. Yeah. Yeah, I'm making the assumption that she is unable to convert the long-term rentals into short-term rentals either because the market would not support that, like demand would not support that, or because there are municipal restrictions in place from the city or from the county that may prohibit that in the location of her long-term. It's a great point. She would have done it already, right? If she likes that and she doesn't like the other, she would have already done it.

I agree with the goal of spend your time doing what you love. The reason that I've presented so many options is because even if the goal is ultimately to sell these three long-term rentals, that doesn't necessarily mean that she would need to or would want to do it immediately. If they're looking at retiring in the next five to ten years, it makes sense to sell off the long-term rentals by the time they retire so that that way they can close multiple chapters. They're done with the long-term rentals. They're done with their jobs. They can close the books on that section of their life and then turn into the next era.

But between now and retirement, it doesn't sound as though there's any particular urgency other than market timing considerations. Market timing is a bad phrase around here, but this is effectively a market timing question. There doesn't seem to be any urgency outside of market timing to get rid of these rentals. And so from a net worth building perspective, there's part of my brain that wonders, might it make sense to sell one of the properties, use the proceeds to pay off the other one, have two long-term rentals, both of which are then paid in cash, assuming there's sufficient equity for that, and then collect the cash flow from the two free and clear long-term rentals until the point of retirement. That's absolutely a possibility,

and that would have to be compared to the alternate situation of sell off one of those rentals, use the proceeds to invest in the market, run a spreadsheet with certain return assumptions about what those market investments will return between now and retirement, and then see if maybe it would be more cost effective to take that same bucket of money, invest it in the market, keep two long-term rentals, one of which is paid off, one of which has a mortgage, and at the end of five years or at the end of 10 years, how much does that pencil out to? From a mathematical perspective, I think if you run through each of these options and make certain return assumptions, how well you think that a given investment will perform between now and retirement versus how much cash would you collect if you were to sell off one property, use it to pay off the mortgage on the other, and then improve your cash flow situation, which then could be put into the market in perpetuity.

those at the spreadsheet level, those are the different scenarios that you could run to see how those would pencil out over a 10-year time span given specific cash flow assumptions and specific return assumptions. Well, and here's the other thing, too, is that by selling them all immediately, she's also changing her asset allocation significantly, where if you change them up over a longer period of time, Paula, it's much more like dollar cost averaging, right? I mean, you're going to win bigger or lose bigger. I don't think either way she's going to lose because both of these are great assets. But what I mean is that her net worth is going to kill it or not kill it based on

much more based on placing a single bet. But rather than doing that and selling them in three parcels over a longer period of time, I think she's a little safer approach. And then the other thing, too, I still think the answer is to sell them. But I think that having a plan where she's selling them individually one by one, like if we get down to the tactics of that, I think that when you sell three things at once, it's just kind of more about how the human brain operates. So you think that if I'm selling three houses and somebody's kind of given me a mediocre offer, not a great offer.

But I have these other two houses I'm selling right now. I'm much more likely to give in on that one if I'm not really focused on it. If I'm focusing on three, I'm like, eh, I'm going to let that go. Like, I'm not going to pay attention to maximizing the value of each of these three houses in the marketplace. Hmm. Just by virtue of having your attention fragmented. Yeah.

Yeah. And, you know, I might not present the house the right way. I might not put as much attention to the listing. And maybe for that reason, too, you'll get more money by focusing on them one at a time. You know, as I think through this, it strikes me also that it's, it's a lot of the that in the spirit of her question, there's a mathematical answer and then there's the quality of life answer. The mathematical answer, as I just outlined, hinges on going to online calculators or running a spreadsheet with a bunch of scenarios in which you make certain assumptions

about how much a home will sell for, what you'll collect after expenses and taxes, etc., etc., you make those assumptions, then you make certain return assumptions, then you compare that to your projected cash flow if an additional house was paid off and you were to then put that added cash flow into the market, dollar cost averaged, right? It becomes a series of scenarios that is so laden with assumptions that it runs the risk of being a little garbage in garbage out because while it's prudent to run scenarios given a reasonable range of assumptions, what's a reasonable worst case, what's a reasonable best case, there's also the risk when things get too mathematical that precision gets conflated with accuracy.

Which was my default response, Paula. My default response was go with quality of life. These are two long-term assets that beat inflation over long-term. periods of time. It's what she's looking for. In my brain, it's a lateral move towards something that will make her happier, but still achieves the same objective. You know, the other thing we haven't talked about is selling the long-term rentals and using the proceeds to buy additional short-term rentals. Oh, that's a good one. She stated that short-term rentals are an absolute love and that she finds great joy in that type of work. And so even if, you're a lot of If home prices are higher now than, of course, they were a few years ago, if that's what lights her up and if that's something that she might want to lean into in retirement, this could be a good opportunity to replace the type of real estate that she's not into with the type of real estate that she is into.

And I think long-term rentals, wouldn't they be a little more price sensitive? In other words, you always want to get a great price when you buy it. But I'm looking at the increased, the huge inflation when it comes to the price people are willing to pay now versus even a year ago on staying in these short-term rentals. I would think that could be a massive income stream bump that offsets the fact that you're paying more for it now. Well, it depends on the property. It depends on how the numbers run. It depends on all of your assumptions about occupancy rate, vacancy rate, the cost of utilities. and consumables, et cetera, et cetera. You know, it depends on all of the unique math behind each property, of course.

Every short-term rental has its own numbers. But I'm saying that the thing that came to my mind is that she talked about the real estate market being high. And I'm saying that in the short-term rental market, she has just such a, I look at the prices that I would pay today to stay somewhere versus a year ago. And I think that the fear that she would have that this is a, quote, high market. almost like the joy she expressed about it being a low market that I cautioned her against earlier. I don't think I'd be as worried about that as long as I make sure that math works.

Right, right. So what you're stating is that rising prices work both ways. The cost of the asset is higher, but the nightly rate is also higher. Yeah, so focus on that math and that individual opportunity much more than the quote market, you know? I think if we can zoom out, the bigger theme. Joe, that I think you and I are both getting to is to think less about market timing and more about how to execute her ultimate goal. I mean, even my complicated tree branch spreadsheet scenario is really a stopgat measure, right? It's very much a what do I do this year. But even that

set of complicated spreadsheet sells ultimately is just the stopgap before she sells these long-term rentals because she just doesn't want to hold them. And life is too short to do what you don't want to do. That is clearly the essence here. Much more than market timing. I felt like market timing was a big part of her question. But I felt like our answers were to throw that away. You know, the irony is that if she throws that away and makes the decision based on what she wants to do, she doesn't want to hold. these long-term rentals, so that means most likely if she throws away the concept of market timing, she would end up selling the long-term rentals and putting the money either into buying short-term rentals or into the stock market, which means she might arrive at the same conclusion that she otherwise would have arrived at had she prioritized market timing.

Try to time the market. Yes. Yeah. It is funny. Our answers are, yes, do it, but for a whole different set of reasons. Exactly. Well, Thank you, Liz, for that question. That was an interesting thought exercise. And I hope the whole community benefited from listening to the way that we worked through the problem. Because so much of personal finance is not what the answer is, it's how to arrive at the answer, thinking about how to think. And your question was ideal for that type of discussion. So thank you, Liz, for the question. Best of luck with whatever decision you make. We're going to take a break for a word from our sponsors, and when we come back, we're going to hear from Rebecca, who is thinking about

contributing to both a Roth IRA and a Roth 401K. But she's worried about what that's going to mean for her tax bill. Stick around. Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in payments technology. built to evolve with your business. 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. The holidays are right around the corner and if you're hosting, you're going to need to get prepared. Maybe you need bedding, sheets, linens. Maybe you need serveware and cookware. And of course, holiday decor, all the stuff to make your home a great place to host during the holidays. You can get up to 70% off during Wayfair's Black Friday sale.

Wayfair has Can't Miss Black Friday deals all month long. I use Wayfair to get lots of storage type of items for my home, so I got tons of shelving. that's in the entryway, in the bathroom, very space-saving. I have a daybed from them that's multi-purpose. You can use it as a couch, but you can sleep on it as a bed. It's got shelving. It's got drawers underneath for storage. But you can get whatever it is you want, no matter your style, no matter your budget.

Wayfair has something for everyone. Plus they have a loyalty program. 5% back on every item across Wayfair's family of brands. Free shipping, members-only sales, and more. Terms apply. Don't miss out on early Black Friday deals. Head to Wayfair.com now to shop Wayfair's Black Friday deals for up to 70% off. That's W-A-Y-F-A-I-R.com.

Sale ends December 7th. Get you and your crew to the big shows with GoTransit. Go connects to all the main concert venues like TD Coliseum in Hamilton and Scotia Bank Arena in Toronto. And Go makes it affordable with special e-ticket fairs. A one-day weekend pass offers unlimited travel across the network on any weekend day or holiday for just $10. And a weekday group pass offers the same weekday. travel flexibility from $30 for two people and up to $60 for five. Buy yours at gotransit.com slash tickets.

Our next question comes from Rebecca. Hi, Paula and Joe. This is Rebecca from Sunny South Florida. I have a question about whether to switch to a Roth 401K. I've been with my employer for many years and I've been maxing out my traditional 401K for most of that time. I made a lot of financial mistakes when I first started out, but at least I got that part right.

I did not, however, know that you could have both a 401k and a Roth IRA until a few years ago, so I didn't open a backdoor Roth IRA until about four years ago. My employer recently added a Roth 401k option to our retirement planning benefits. Although I understand the benefits of having money saved in Roth accounts, I have still been maxing out my traditional tax-deferred 401K to reduce our tax liability because I am a very high-income earner, and the last couple of years have made over $400,000 a year. My husband has a small business from which he's able to deduct a lot of business expenses, and we also max out my HSA and the flexible savings account to lower our tax liability.

In addition, once I made partner a few years ago, I was eligible to participate in a profit sharing plan and to contribute around $20,000 a year, which my employer deposits in the traditional 401k. So I'm effectively saving over $40,000 in the traditional 401k account a year. I'm torn between trying to reduce our tax liability as much as possible while also recognizing that we have no idea what the tax brackets will look like 30 years from now. I'm 43, my husband's 45. we have around $520,000 in the traditional 401k, but only $23,000 in a backdoor Roth,

$17,000 invested in HSA and $8,500 in an individual brokerage account. We also have around $75,000 in cash for an emergency fund. I plan on staying in my job for at least another 10 years, and my mortgage will be paid off in nine. And even if I leave my job in my early to mid-50s, I'll still find work elsewhere, though probably something with a much lower salary. I realize that there is a large discrepancy in what we have saved in a traditional 401K versus what we have in our backdoor Roth. and I'm wondering if I should bite the bullet and just switch the contributions to go into the

Roth, but I'm also scared of what that tax bill will look like. Appreciate any advice you can give on this issue and, you know, what's the best option for us? Thank you. Rebecca, thank you so much for the question. First of all, congratulations on making partner, on saving such a big proportion of your income, on building the investments that you've built, and on recovering from financial mistakes that you made earlier. You mentioned that you made some mistakes early in life. I love that you are willing to talk about that. And I love that you have learned from that. And I hope that that

inspires anyone who's listening who is thinking themselves, geez, I'm making a bunch of financial mistakes right now. This is all a learning process. So I love that you keep learning and keep improving. So to your question, one concept, Joe, that I actually learned from you is the tax triangle. Joe, as you talk about, and I'll paraphrase you while you're sitting right here, it is often prudent to have money in taxable brokerage accounts, tax deferred accounts, and tax-exempt accounts. Now, Rebecca, as you mentioned, there's a huge discrepancy between the money that's in your traditional 401k, which is tax-deferred, and the money that's in your backdoor Roth, which is tax-exempt. I can very much see an argument for building out.

the weakest corner of that tax triangle so that when it's time to tap those retirement accounts, you will have a good bucket of assets that's tax deferred and a good bucket of assets that's tax exempt, and you will then be able to make strategic decisions about which bucket to pull from depending on the tax code at that time. And like you said, it is impossible to know what your tax brackets are going to look like 30 years from now. It's impossible to know what what the tax code is going to say 30 years from now. So building out that triangle in order to maximize your flexibility and your options in 30 years can be a very wise and forward-looking move. Can we stop right there, Paula, before you continue?

Sure. You know, speaking to some of these experts that I know you've an appreciation for a gentleman named Ed Slot, David McKnight, not sure if you know David McNight, but these are wise people on the tax code and give good tax advice, competent tax advice. They both talk about when it comes to taxes have two options. And both of them are options only because, Paula, when you do the math, just like you would on your budget or my budget, the amount of money coming in is not matching the amount of money that needs to come in to balance the budget and pay down the debt.

And if we're going to do that, there's going to do that, there's a lot of money. really are only two things. There's going to be some significant, significant moves that the government will have to make to write off debt, which would be amazingly ugly. We'll be so, so, so ugly that we doubt that that would happen. It could happen, but that's number one. Option number two is that a much more straightforward is we just start raising the tax rate. So from a bipartisan standpoint, not being political at all, if we're going to actually make the budget work, there is a high degree of likelihood that tax rates will be higher than they are today, 10 years from now, 15 years from now, 20, 25 years from now.

It's also worth noting that if you look at historic tax rates over previous decades, we at this point in history have a relatively lower tax rate than we have had in the past. I, as you know, don't like to predict what will happen in the future, but I do like looking at historic data to see how the present compares with the past. And if you look at the top marginal tax brackets from previous decades. Super high. Right, right. Much higher than it has been today. 70% sometimes. So again, we don't know what the future holds. I'm very reluctant to make any predictions about the future. But we certainly know how our current position compares to historic data. And where Rebecca's sitting now, Paula, I mean, there's a good probability

based on what she's telling us. She's in the 35% tax bracket. So even though we're saying this is relatively low comparatively, if she's going to switch from the pre-tax to the after-tax, but tax-free from here on out Roth 401k, she's going to start paying 35% of her paycheck today into the system versus shelter that money from the beginning. So I get this pain that she is reticent to experience by making this change. Right. But that said, the beauty of a Roth account is that, Rebecca, as you know, all of the capital gains, all of the dividends, all of that growth is tax-examination.

exempt forever. If you imagine how much that money could grow and compound over the span of several decades, that's a significant amount of growth that is all tax exempt. I think I hear you loud and clear, Paula. I think I know what you're laying down. I mean, I hesitate to tell people what to do. I like to give people a framework for how to think about the options. And that's why I started the answer by talking about the tax triangle, which essentially is an answer that points to maximizing flexibility and maximizing options. Over this idea of just optimizing one way or the other, which by the way, it gives us another outcome because she is this binary outcome and that is not the truth. You can actually split your contribution.

Right, exactly. So long as the total contributions are within the limits, she can. contribute to some amount of money to her traditional 401k and some amount to a Roth 401k. So she knows already, Paula, what the problem is, right? She knows there's not enough in that bucket. That was part of her question. So she gets it. She knows the race is to build that as much as she can. So I don't know.

My answer to her would be take the number that you can put in there without grimacing too much and make that your Roth contribution. and just remember that it's about steps toward building flexibility in this game versus going cold turkey one way or the other. I think she's just got to pick a percentage of that contribution that she can make without groaning too much and bite it off, bite off that part. But I will also say, Joe, to that point, picking a percentage is behavioral, It will help her deal with the grimace.

But when we look at the disparity between the $520,000 that she has in a traditional 401k and the $23,000 that she has in a backdoor Roth account, I mean, we're talking an order of magnitude difference. Yeah. We were talking about math with Liz earlier. The answer is 100% the Roth. But the cool thing is she doesn't have to do that. Right. She doesn't have to. She will build more flexibility with every dollar she puts on the Roth side.

So I'm all for behavior that is, hey, I'm going to start with, you know, 50% of my contribution is going to be on the Roth side. I think that's fine. Essentially, there's the answer that most effectively builds out the tax triangle, but then there's the answer that is behaviorally easier to swallow. And she can pick either one. Yeah, good enough for me. What do you think? I think we, I think we've given her an answer. Wow.

Rebecca. So Rebecca, thank you for that question. Best of luck with building out that tax triangle. Paula, our next question comes from anonymous. And as you may know, we give every anonymous caller a name. And our new game that starts right flipping now is that because Paula is going to be interacting with some of the world's most famous and best journalists now here for the next several months, we should point towards some of those people. Let's stop playing the film game that we've played

previously, and let's start playing the journalist game. So which journalist would we like to name Anonymous after? Back in 1963, there was a publisher named Catherine Graham who took over the Washington Post after her husband passed away and led the post during the Washington Post's printing of the Pentagon Papers and the Watergate investigation. She wrote a memoir in 1998, which won a Pulitzer Prize. So, in honor of her, let's name the next caller, Catherine. Hi, Paula and Joe. First of all, thank you so much for everything that you do. I'm a 31-year-old. I'm single. I I have 40K in emergency savings, and I also have a retirement account, but that's not exactly relevant to this conversation. This past year, I went through a career pivot and I sold a house.

I will not be eligible to participate in my new companies 401K until about October of this year. My income is going to be about $105,000 from employment this year with extra income of $76,000 on a house that I sold earlier in the year. Now I will have to pay capital gains on that house because I held it for less than two years and just had to sell it before I'd owned it for two years. My goal is to reduce my taxes that I'll have to pay next year as well as save her retirement. So this year I contributed $1,000 to my TRA without realizing that because of my income, I don't think that that's actually going to be deductible. So I don't know how helpful that was. In the meantime, I've just started to contribute to a regular taxable brokerage account, which I'm fine with, but I would much rather optimize my tax strategy.

So my question is, should I, once I'm eligible for my company's 401K, put my full paycheck towards that 401K? Is there any limit for someone who is only eligible for a 401K for a partial portion of the year and not the full year? and is there anything else that I'm thinking of that would help me reduce next year's taxes? Again, I'm really concerned about this like 15K or so that I'll owe on the house. Or is there anything else that I'm not thinking of? Thank you so much. I've learned so much from both of you, and I really appreciate it. Catherine, thank you so much for the question, and congratulations on all the big changes that you're making.

You have a new career, you sold a house, you've got some big life events that are happening right now. So congratulations on all of this. Now, you mentioned that you contributed $1,000 to a traditional IRA prior to realizing that due to your income, that contribution will not be deductible. So you made a non-deductible traditional IRA contribution. If you wanted to, you could make a backdoor Roth contribution with that money. So you can move that $1,000 from a trad IRA into a Roth IRA, and that would, then be a backdoor Roth contribution.

Love that advice, Paula. And the only thing that I'll add is that if some investments that she may want to go into have minimums, so she may want to actually add to that, which she's allowed to do. So it doesn't have to stop at 1,000. So if wherever she's going is $2,000 minimum to get into it, she could do that. But I think it's probably the opposite of what she wants to do since she's trying to cover up the house sale. Well, it's funny because there's the question that she asked, but then there's also the zooming out, the bigger picture goal. If the bigger picture goal is, in part, to say for retirement, making a backdoor Roth contribution or a larger backdoor Roth contribution feeds that goal. So it does not reduce the taxes that she'll have to pay next year. But as we just discussed with Rebecca, it certainly reduces the taxes that she would have to pay in retirement.

It's an interesting conundrum because I get it on one hand, who wants to come up with that type of cash to pay that? But the funny thing is, is that at this point, you're just trying to reduce the pain, right? You can't reduce the tax. The tax is going to happen. So she needs to reduce the pain of the tax by covering it up in another area, which, you know, use the phrase zooming out earlier with Liz. I think it's the same here. If you zoom out, the true goal is not to save money on taxes. The goal is to have more money.

Right. Like I often find that investors let the tax tail wag the more money dog. Right. You know what I mean? Truly, I would love to have Bill Gates tax bill. Like, that would be incredible. But that said, if she can cover it or doesn't have a great way to cover it and needs to figure out how, then by all means, we should do it.

it pivoting then to the other half of the question, which is how much can she put in? There are two rules that may conflict with each other. There's a good news piece and a bad news piece. The good news, Paula, wow, what am I telling you? You already know this. I should be telling everybody. Hey, everybody, guess what? Catherine can put in the full amount as if she worked there the entire year.

With the exception of companies will often only let you put in so much per payroll. So the company might slap her hand and say, oh, you're putting in too much at one time. But if the company does not do that, then by all means, she still can max fund that 401K if she's able to and wants to. Exactly. So chucking every paycheck into that 401K for the rest of the calendar year is a beautiful way to both save for retirement and lower the tax bill. Best of both worlds. Yeah, I hope her company will let her. There are some companies that won't.

And oh, man, I hope they do. Thanks for that question, Catherine. And by the way, Paula, I think that was a good segue for our first time switching from movies to journalists. Because in 2017, there was a fantastic movie about Catherine Graham. And it was directed by Steven Spielberg. It starred Meryl Streep playing Catherine Graham as the larger-than-life, Ms. Graham. and Tom Hanks played the role of Ben Bradley. And man, the names that were in this, Bradley Whitford, who was in the West Wing, comedian David Cross, who was in arrested development.

Bob Odenkirk, of course, Better Call Saul and Breaking Bad. Wow. Just great film from 2017. So a nice handoff, Paula. Oh, wow. And you probably didn't even know you were doing it. I had no idea. I had no idea.

I had no idea there was a movie about her. But that sounds like a great cast of characters. I might check that out. Who am I kidding? I won't. I don't watch movies. You totally should, though. And with the whole journalism thing, and should we run a story, should we not run it?

What are the ethics of this thing? Like, that's exactly what you're going through right now. And I think you would flip and love it. We'll find a way at some point to sit Paula down and get her to watch it. Get me to watch a movie. Good luck. I only watch movies on airplanes. I'm going to tell her there's macaroni and cheese ice cream at the end.

If you watch this, we have a pint of ice cream sitting at the end of this, Paula. Macaroni and cheese flavored. That's like the pot of gold at the end of the rainbow. That is. Paul, it's as gross as you want it to be. It's delicious. You do not know what you're talking about. We'll come back to the show in just a second.

But first, all right, we've got one more question today, and this question comes from Kyle. Hi, Paula. This is Kyle from Pennsylvania, and I'm calling about our primary residents that we were looking to turn into a long-term rental as we are moving out of this home into my wife and I's dream home. Basically, I'd always envisioned renting this out long-term, but looking at the way market is now and possibly avoiding capital gains tax in the future, I didn't know if it made sense to consider selling now. A little bit of background. The home value is probably around 300,000. And our...

remaining mortgage balance is about 190,000. So really, like you said, we don't know if it makes sense to hold on for the long term or kind of cash out now and avoid paying capital gains tax and also avoid dealing with the hassle of being a landlord and such. Our third option two, which I don't know a whole lot about, is rent to own. I've heard a lot of people talk about this and say that that's their ideal situation. But being on the other end of it, I just don't know the specifics and if it's something that makes sense to try to lock in a sale price now and be able to comfortably rent that place out until that closing. Really curious your thoughts. Thank you so much. Kyle, thank you for the question. Congratulations on moving into your dream home.

Let's talk through your options. Number one, you mentioned, and taxes have been a theme of today's episode. You mentioned wanting to avoid capital gains tax. The good news is you have two years to sell this property without needing to pay capital gains tax. So I have good news. The rule is that if you have lived in a property for two out of the last five years, then you won't have to pay capital gains tax up to a certain limit, but you are well below that limit. This isn't a decision that you have to make immediately.

If you wanted to hold this property, use it as a rental for a year, get a sense for what that experience is like, and then make the decision. You could do that without encouraging. capital gains tax. So the good news is you've got some time on your side. You've got some flexibility there. I think the first question that I would start with is do you want to hold a long-term rental or not? This goes back, Paula, directly to what we said to Liz. Exactly. Exactly. There's no reason to hold a rental if it's not what you want to do, just as we told Liz at the beginning of

this episode. The worst reason to do it is because you look around the financial independence community and it seems like everybody else is doing it, don't do it just because you feel a sense of peer pressure or you feel a sense of everyone else is doing it. And I'm not saying that's your motivation, but I'm saying this for everyone, the sake of everyone who's listening. One of the worst reasons to become a rental property investor or to become a landlord is because you're motivated by a sense of fomo or you're motivated by a sense of everyone else is doing it, therefore I should too. But if your motivation is to, you're motivated. If your motivation is different. If your motivation is, hey, I've been hearing a lot about this. I'm curious. I'm curious

about what this would be like. I'd like to give it a try. All right, that is a much better reason. If your motivation is, hey, I've got assets in index funds and stocks and I want to diversify, I want some mix of my assets to also be in real tangible properties and not just in market investments. All right, that's a great reason. So there are plenty of great reasons to do it, and there are plenty of not so great reasons to do it. So I would start with what's your motivation, what's your why in determining whether or not you want to go down that road? Now, to your question about rent to own, there are a couple of iterations that that could take. There is something that's referred to as a lease option, which obligates you as the seller to sell the property.

There's also something that's called a lease purchase agreement, and that obligates both parties, you as the seller as well as the buyer, to the sale of that property. The practice of lease options and lease purchases came about because tenants would often want to buy properties from their landlord, but often couldn't qualify for an institutional loan. And so landlords saw an opportunity to allow a tenant to live in the home and either, depending on whether it's a lease option or a lease purchase, either commit to buying that home. home or have the option to buy that home. So if you sign a lease option with a tenant, then the tenant can exercise the option to buy the home from you for a specified duration of time. And if the tenant exercises that option, then you would be required to sell the home to that tenant. The challenge that you're going to have with both of these is that you still have an existing

mortgage on that home, and that is going to complicate matters greatly. It's not to say that you can't do it. But when there is an existing note on the home, it, it, adds a certain level of complexity that is not present if you were to own the home free and clear. Taking a step back and zooming out, this is the first time that you've ever thought about holding a rental property or an investment property. The question that I would ask you is, do you want to go down a more complex road as a first-timer? And if so, would the payout, the potential payout, be worthwhile. Given the learning curve, given the complexity, given what else you could be doing with your time, and given the fact that you would be

collecting the interest rather than the bank, and that is some money, but there are lots of ways to make side income. Given all of that, as a first timer, do you want to pick an intermediate strategy, and I would say lease options, lease purchases, these are intermediate strategies. They're not beginner strategies. Or would you rather take a test run for a year, see if you like holding an investment property, and then if you like it, once you have that first year learning curve under your belt, then you can start to advance. I think the theme here, Paula, though, is clear, again, deciding what you want to do based on joy over markets, opportunities, start off with what you want to do.

Yeah, it's funny, Joe. Each episode inadvertently tends to have a theme. It totally does. When I looked at these questions, I initially thought that the theme of this episode would be real estate and taxes. But as we have gone through and answered, the true theme of this episode is to ignore market timing, to ignore the temptation to over-optimize, and to ensure the temptation. Instead, start with how do you want to direct your time, energy attention?

Optimize your life. Yeah, if we wanted to save some time, we could have said to Kyle, hey, listen to our answer for Liz. And then pretend we said Kyle instead of Liz. And you're good. No, actually, there were obviously some differences. But there are these great benchmarks in these episodes, these larger, more philosophical points that I think help us all become better. Not just better investors, but I feel like better life livers, you know? I mean, you see these people that spend all day, every day grinding for a future that they really don't care about.

And that's frustrating to see. I've often been guilty of making the decision that is practical rather than the decision that I want. And rationalizing to myself that this is the right choice because it is practical. And then years later, spending far more time, money, and effort untangling and undoing that decision because invariably, it wasn't what I wanted so it's not sustainable for the long term. Yeah. Me too. And the older I get, the more I think about legacy in terms of what do I want to be versus what do I think. Society wants me to be, some boss wants me to be, my neighbors want me to be who should I be. And it becomes a lot more personal, but then it also makes my goals stickier,

makes me much more likely to do the things that I want to do and to fight off frustration a lot more. You know, if I'm fighting a battle because I'm trying to press somebody else versus doing what is best for me or something that I think I should do, right? This ethic that I have to do this thing. It is funny because we think about these ethics if we're going to get just a little phil philosophical for a second. There's there are a few of these that are kind of the quote American way. One is a college education and the other one is buying a house. And you think about the rethinking of both of those that we've done on this show. And don't get me wrong, we value both of those things. They're fine goals. They're fine values. But they're not this ethic, this this citadel on a hill that we should all be working toward. You know, they're intensely personal.

to us. And you see the outcome of going after either one of those without thinking through, does it really matter to me? And what's the true ROI? I mean, last time I was on a couple episodes ago, we talked about the true ROI of owning a primary residence is much more in your own happiness, far more in your own happiness than any true net worth statement ROI. The net worth equation is garbage. And this idea of throwing your money away on a house is nearly the same. in reverse as you're throwing your life away if you don't go to college. Also not true.

Neither one of those are true. Right, exactly. Neither one of those are true, but they're myths that we've been fed and need to actively unlearn. To the point that my friends, very smart people that did not go to college, often feel, they tell me they often feel this sense

of people judging them, you know, oh, you didn't go to college and they have to feel, they feel a little defense. And if you really sit back and think about that, there's no reason to be defensive about not going to college, really. I didn't check this box. I mean, that's how strong that box is. Right. It's crazy.

But if we lead with joy, I think we get where we want to go, which is what I really enjoyed, by the way. You enjoyed joy? I enjoyed Mr. Money Mustache's piece on this. I don't read the Mr. Money Mustache blog that often. And I was glad that I caught this one because it truly is. if all roads lead to the same place, which they don't, but sometimes they do in this case, right? In the case of Kyle and of Liz, they do lead the same place. So lead with the thing that gives you the most joy.

So the article, Joe, that you're talking about, and we will link to this in the show notes. You can subscribe to the show notes for free at afford anything.com slash show notes. But the name of the article is, which is safer, rental houses or stock investments? It's a long article, so I won't read the entire thing. but I will right now read an excerpt from it. Quote, so perhaps the main difference between Aaron and myself is that I think of houses and stocks

as being two versions of the same thing. They are both real, concrete, productive assets rather than gambling instruments or numbers on a computer screen. If you understand this connection, you will become a better lifetime investor. Meanwhile, people who understand only one, side or the other may become blind to what investing really means. The real estate faithful

will often talk about the concrete nature of their investments. Their houses and apartments really exist, and they provide the service of housing to their tenants, which is an essential human need. In exchange for meeting this need, the investor collects rent, which is a genuine and sustainable source of income. But sometimes these people will go too far and insist that real estate is the only true investment, becoming blind to the value of investing in other businesses via stock ownership. This blindness can lead to crusty multi-millionaire landlord syndrome. The guy who owns 400 rental units and is always looking for the next deal, yet can never truly sit back and feel retired no matter how big the empire grows. The stock market faithful may develop a different

problem, a focus on stock prices rather than business ownership. When you hear people talk about the 200-day moving average, or support level, or death cross pattern, you can safely assume they suffer from this condition. And it's the same thing that powers price speculation on things like crypto coins, meme stocks, and other volatile fads. They are hoping for an outcome, rising asset prices, without considering the thing that actually creates the underlying value, earnings. So, what would I do? I'd keep the houses that I love to live in and sell the rest if I'm only managing them for the money. I would dump a huge chunk of surplus cash into the sensible index funds through the financial firm of my choice, feeling extra good about the fact that stocks

are currently on sale. And then, I'd keep doing construction projects alongside great friends just as I do now, only when it suits me. When evaluating a new project, instead of asking myself about the potential profit, I would ask, is this project so worthwhile that I would do it for free? If the answer is yes, go ahead and do it and celebrate the profits and use them to facilitate even more generosity. I think he makes such a great point. If you're going to take on more work for an investment or an opportunity, just any opportunity where you could get the same result with less work, you should ask yourself, would I do that for free?

Right. Because if I'm going to have the same result, why the hell would I go through the pain if I wouldn't do it for free? Right. That resonated with me this summer. Thanks to the read, you should reach out to Pete and ask him if you could be his audible representative. Good little commission off of Mr. Money Mustache. That could be a good gig.

I would do it for free. Well, Joe, I think we did it again today. We did. That was fabulous and unexpected. Unexpected. I did not know we were going to go into some of those places. And it was super fun. Absolutely.

Joe, where can people find you if they would like to hear more of your ideas and your creation? Say hello to me on Instagram. We have fun on Instagram every Wednesday. We have a Instagram live where I hang out with our. our stacker and afford anything friends. It's 5 p.m. Eastern, I'm there. We also, when I went around the country, partly with you, Paula, I also did some cool interviews for a nonprofit called Million Stories, and you'll see all of these regular

people like you and I, you'll see their stories as I interviewed somebody in every city. And I heard some people are so brave, Paula, just some of these people telling some stories out loud that are so helpful to other people, but also so personal. they were a lot of fun to do. Those are all on our Instagram page. Just put stacking Benjamins into the search feature and follow us. Awesome. Well, thank you, Joe.

And thank you to everyone tuning in. No. Thank you, Paula. Oh. Thank you. Aw. Yes. Aw.

Well, thanks, Joe. Thank you, Joe for thanking me. You're welcome for thanking you, Paula. If you enjoyed today's episode, the way that you can thank me is by subscribing to the show notes, which are free. Affordanything.com slash show notes to sign up. Right? Yeah. Look at that. Ninja. Ninja. Please open up whatever app you're using to listen to this podcast and hit the follow button so that you don't miss any of our amazing upcoming episodes. And while you're there, please also leave us a review. If you want to chat with other members of the community, head to Afford Anything.com slash community. And if you want to find me on Instagram, I'm Paula Panth, P.A.O.

ULA, P-A-N-T. Thanks again for being part of this community. This is the Afford Anything podcast. I'm Paula Pant. And I'm Joe Sal C-Hi. And we will catch you in the next episode. Here is an important disclaimer. There's a distinction between financial media and financial advice.

Financial media includes everything that you read on the internet, hear on a podcast, see on social media that relates to finance. All of this is financial media. That includes the Afford Anything podcast, this podcast, as well as. as everything afford anything produces. And financial media is not a regulated industry. There are no licensure requirements. There are no mandatory credentials. There's no oversight board or review board. The financial media, including this show, is fundamentally part of the media. And the media is never a substitute for professional advice. That means anytime you make a financial decision or a tax decision or a business decision, anytime you make any type of decision, you should be consulting

with licensed credential experts, including but not limited to attorneys, tax professionals, certified financial planners or certified financial advisors, always, always, always consult with them before you make any decision. Never use anything in the financial media, and that includes this show, and that includes everything that I say and do, never use the financial media as a social media. substitute for actual professional advice. All right, there's your disclaimer. Have a great day.

But if we lead with joy, which was, I think what we should call this episode, I think we should call it Joy, who is she and why do I want more? Steve cut that.