Afford Anything - Q&A: We Save $5,000 Per Month. Where Should We Invest It?

Episode Date: April 12, 2024

#499: Eugene and his wife are retiring with a $10 million net worth and a guaranteed income that exceeds their annual budget. Do they still need things like life insurance and a financial advisor? The next question, at 30:24, comes from an anonymous caller. Her HOA costs have doubled since she bought her condo. She’s wondering if it’s still a good investment. Should she keep it or sell it? We answer Nandini’s question at 48:14. Nandini and her husband save tons every month toward no goal in particular. What should they do with all their extra cash? Former financial planner Joe Saul-Sehy and I tackle these three questions in today’s episode. Enjoy! P.S. Got a question? Leave it at https://affordanything.com/voicemail For more information, visit the show notes at https://affordanything.com/episode499 Learn more about your ad choices. Visit podcastchoices.com/adchoices

Joe, when you save money, where do you save first? What accounts do you first put your money in? I'm not going to divulge that. Are we on some type of a podcast where we talk about like where to save first? Oh, I see. So that's privileged information. Well, yes. Would you all like to know?

Oh, well, I would like to know. And we're going to get to that at the end of the show because one of our callers has that exact question. But that's not all that we're going to be talking about. We're also going to be hearing from Eugene, who has a $10 million net worth and a series of questions related to how to manage a high net worth. And we're going to be hearing from an anonymous caller who is wondering, should she sell her condo or should she rent it out? Welcome to the Afford Anything Podcast, the show that understands you can afford anything, but not everything. Every choice that you make is a trade-off. And that applies not just to your money, but to your time, your

focus, your energy, your attention to any limited resource that you need to manage. So, what matters most and how do you make decisions accordingly? Answering these two questions is a lifetime practice. And that's what this show is here to explore. My name is Paula Pant. I am the host of the podcast. Every other episode, we answer questions that come from you. And my buddy, the former financial planner, Joe Saul Seahide, joins me. What's up, Joe? I'm so happy to be here, Paula, with you on episode 499. 499. We're going to party today like it's 499, too.

Yes, exactly. We recorded episode 500 live. The audience was also really sad that you weren't there. You had to be invited, Paula. Oh, yeah. I only invite people who don't gatekeep where they save their money. Oh, tush. Let's focus on episode 499.

Oh, let's do it. Let's close out the 400s in an amazing way. First, we're going to hear from Eugene, who is wondering how to manage a sizable net worth. Here he is. Hello, Paula and Joe. I'm a 55-year-old married man with a wife who's 56 and two children 20 and 17. We're both physicians. Our base salary is over $1 million a year.

We own three homes for a total of $2.53 million in value. We have a mortgage on our principal home of $197,000 at a 2.55% interest that will be paid off in four years. Our assets, we have a joint taxable brokerage account of $1.14 million, invested in index funds, and a combination of 401k worth $3.5 million and Rothier plans worth $1.1 million for a total of $5.6 million in retirement funds. Our two children's education is fully funded with $529 plans. And at retirement in four years, my wife will receive a $1 million payout from her employer. At age 60, we'll have a combined pension of $272,000 annual, which does not include the $1 million payout.

At age 71, we expect to collect Social Security benefits to $96,000 a year combined. We have free health care for life and our total retirement expenses given travel and other expenditures to be roughly $265,000 a year. We have four indexed universal life policies with a cash value of $800. $173,477.77. We stopped paying the premium on our two children, but we're still paying $1,000 a month for me and $500 for my wife. My policy death benefit is $1.5 million, and my wife's policy is $750,000. We have separate term life insurance policies for our employers, minus $500,000, my wife's $2 million. The policy has a downside protection of 1% and an upside cap of 7.5%. When we look at a 20-year rate of return, it's 5.64% through the index universal life compared to the SMP,

P's 7.62%. So here's the question. Number one, should we continue the policy into our deaths? Life expectancy calculators has us out to 90 years old. We see the cost of insurance rapidly rising after we turn 80, but we can afford it. Number two, should we surrender our life insurance policy and take the cash value and pay taxes on the appreciated value? Number three, should we continue to borrow against the policy over time and let the policy slowly lapse? If we're to do this, when and how should we do this? We don't need the cash at this time, nor do we expect it. any large infusion of cash in the future. Should we invest more in our broker's account with a potential increased tax liability for our children upon our deaths? Or four, any combination of the

above. And five, finally, any thoughts on a financial planner. Some planners have wanted us to buy more life insurance. Others are using the asset under management model, but given our net worth of $7 million in the market, we would be expected to pay $52,000 to $70,000 a year in financial planning advice. We presently do a DIY financial planner that charges $4,000 a year, but we're looking for other options. Any thoughts? Thank you so much, Paula, and Joe, for your help. Eugene, wow. You know, Paula, halfway through that question, I thought Eugene was going to ask, you think I'm going to be okay? And you know what? I hope everybody's laughing because, of course, Eugene is going to is going to be okay.

But this creates a whole different set of problems that are just juicy, nerdy problems for financial planners or ex-financial planners like me. So I got really giddy when I heard this question because these are the exceptions that we often talk about. But before we get to that, I want to point out one thing, especially in money nerd communities like ours, and I say that with pride. I wear my money nerd badge with a lot of pride. We think about the expense side of the equation.

We think about the asset side of the equation. And I would lead with this. What I think Eugene has done a great job of is the income side of the equation. Because Paula, while certainly you can mess up on a million dollars a year, it is far less likely that you will struggle to grow your net worth on a million dollars a year than it is on $30,000 a year. And often when I was a financial planner, I would meet wonderful people that were struggling with a budget that was super tight, with a wonderful appreciation for asset management and for putting money in the right place. But it was purely an income problem. It was 100 percent you need to make more money.

I want to answer the question about the insurance first because that, There are two issues here. And this also spirals into Paula the discussion about advisors. Because what Eugene led with were two different options. I have potential advisors who want me to buy more insurance. And I have other potential advisors who want to manage my money for a percentage fee that is absolutely huge based on the amount of money that they would be managing. I don't think either one of those places, Paula, is where we start. if somebody comes in and they're like, oh, you need to buy more insurance, don't like that.

Somebody goes in and goes, hey, let's manage all your money. Don't like that either. What I like is this. An advisor first has to ask, where are we going? What's the mission? The biggest threat to Eugene's retirement and beautiful asset base that he has done a wonderful job with, the biggest threat to that during his retirement is a catastrophic illness. which will suck tons of money out of that asset base.

So that is threat number one, especially since he has health care completely covered. So catastrophic illness, meaning long-term care issues, are the biggest threat. One solution that a lot of financial planners like is a life insurance policy that is a long-term care rider attached. and if he already has a life insurance policy that has that rider or maybe could have that rider added to it, and he already has sufficient cash inside to float that policy, this might be a great use for those policies. So I'd want to talk about that. There are other thoughts going in my head, which is around legacy because Paula, with this

asset base that Eugene and his and his family have accumulated, I want to know what he thinks about that money beyond his lifetime. And we do that by weighing long-term care versus what would you want to do with the asset base if you weren't around, which is going to be the second half of my answer around the life insurance. But the first thing you always should do while you're saving is think, what is the threat? You know, what's the, how do I make sure that if something bad happens to me that this doesn't derail my plan. And you see people that have very little difference between money coming in and money going out. The first thing they cut is insurances. Sadly, that's the thing that you can't cut. Eugene would be better off cutting insurances than somebody

who's very, very close to the vest and just starting out. Because for that person who's very close, Paula, it could ruin everything. Right, right. Whereas. when you have sufficient money, you can self-insure. Absolutely. Yeah. Now, my assumption is that part of the life insurance, and this is purely an assumption on my part, Eugene has not stated this, that part of the motivation may be estate planning related. Let's start off here.

The United States has a federal estate tax. It starts to 18 percent and very quickly goes up to 40 percent of an estate. So this estate tax can be big. Now, on top of that, some states. also have an estate tax on top of that. In 2024, Washington, Oregon, Minnesota are a few of them. You can use the Googler to find out if your state is and exactly what it is. But this estate tax could be a problem, but for 99% of it, it's not. But it really is neat, Paula, to see how this system works. So the estate tax starts off with the first dollar. However, every person who's a U.S.

is and gets this ticket. And this ticket is kind of like, you know, they get out of jail free card that you get when you play Monopoly. This is a get out of a state tax free card that you get. And in 2024, that number is 13.61 million. Now, for a lot of people, they think, well, I'm not there. And certainly, Eugene probably, when he just looks at his properties and his ask sets. He's not there, but you throw in this million dollar payout his wife's going to get.

He's even closer. And guess what else counts, Paula? The death benefit on those life insurance policies counts toward your estate. And all of a sudden, $13.6 million is get out of, get out free ticket. He's at, he's close to $12 million. Now, you still think, okay, you know, the average person driving down the road, listen to this is going, okay, well, he's still a million and a half away. Yeah, well, this money is going to grow and compound over time. With his health care covered and the pension coming in, he could have very liberal spending, Paula, and I'm fairly certain his asset base is still going to grow, even is he spending. I'm confident that if he lives to 90, he's going to have significantly more than 13 million.

Huge. And that number will go up, but I don't think it's going to go up faster than he's growing it. So we do have to prepare for him for an estate tax. He and his spouse can set up a two trust system to make sure they take advantage of both of their full tickets to use my verbiage, right? They're 13.6 million ticket. So let's say Eugene dies first. The first 13.6 million goes into Eugene's trust to lock down that they fully use his ticket. And then his spouse now controls the rest of this.

This is called an A-B trust situation. He's got trust A, she's got trust B. We use 13.61 for him, and now we have 13.61 for her, and we've now taken advantage of both tickets. So a good estate plan will do that. But the other cool thing, Paula, and this again depends on what he wants to do, and if he's really worried about his estate and his legacy, because he could also set up a separate trust, he can say, I don't own these policies anymore. more, I'm going to set these policies in something that somebody else controls. Hypothetically, let's say you're a friend, Paula. You will be the person that controls the trust, not Eugene.

Eugene has to completely have his hands off of that trust for it to make sense. So he has to very carefully trust who he's going to pick is the trustee of that trust. And this life insurance goes into this separate trust, which Paula controls. Eugene hands the money to Paula. Paula, Paula puts the money in the insurance policy inside the trust that life insurance now swoops in and pays the estate tax. Bam. And it comes from outside of the estate because Eugene gifted it to Paula who put it in the trust. And by the way, there's a state planning attorney screaming that that's not 100% accurate.

It's close. And my goal is to make sure everybody understands what hell's going on. This is directionally what's happening with this trust. So if he's worried about that estate tax, that life insurance could be used for that purpose. I'm going to split a couple hairs. I don't love that type of insurance, that specific insurance policy. I think whenever you use an equity index policy, you're giving away returns. It's the same reason why J.L. Collins recommends VTSAX for a place to start.

Total Market Index. Take the guardrails off. we don't need the bumpers for this polling. We know that even if Eugene doesn't live for a long time between him and his spouse, just trusting the market's a better way to go, either use a straight up variable universal life policy that is mutual fund like things inside of them. That can cure the difference in return between what Eugene's getting and what the market's been doing, which, you know, he's losing, what, a third of the return roughly

that the market's getting by using this product. If he's going to use it for estate planning, a better type of policy is called a second-to-die policy because we're not worried, Paula, about when Eugene dies. We don't care if it pays then because you've got that two-trust system set up, right? A second-to-die policy only pays out when the second person dies. It's generally a cheaper cost of insurance because, Paula, if it's you alone, they're going to use your actuarial table. And we don't know.

The actuaries don't know when you're going to pass away. But if you have two people, two lives, there's a significantly better chance. One of you is going to have some longevity. And for that reason, actuaries can back down the cost of the policy and make it better. That's a long way of saying that I think there's some significant questions that need to be answered first. What do I worry about the risk of long-term care? What do I worry about my legacy? What's the direction I want to go with my estate?

what's my spending going to be like in retirement? And once I answer those questions, then I go chicken or egg, right? With these life insurance questions. It's an exciting financial planning question. It's a great place to be. But I don't like either one of these two advisor options that he's looking at right now, because I wouldn't lead with either one of those. What would you lead with?

I would lead with specifically, what are my, goals during my lifetime for me and my family and how do I want to spend money? How do I make the best use of this money during my lifetime? Is there going to be more money that I can spend? You and I both agree, maybe? Are there bigger opportunities in my community that I want to support? What are the ideas I have around charitable giving or around legacy planning for my family? And then how am I going to handle a long-term care stay if it happens? How do I feel about that? would I rather self-insure or do I want to give it to an insurance company? And then I look at what you already have, the products you're already invested in.

And then I look at the things that are out there. And I think then once I have those, Paul, it's a much easier decision of what do I have that works and what should I get rid of? And this new information I have about this new investment option does it actually fit my goal? Because instead of them worrying about FOMO, all I'm worried about is, is does the investment meet the end result that I'm looking for? And the cool thing, Paula, is that instead of wondering whether an investment was a good idea or not and second-guessing yourself all the time, the only thing you're wondering is, will my money be where I need it when I need it doing the thing I needed to do?

I like that approach much, much, much better. In other words, start with the end in mind. Where have we heard that before? Right. Stephen Covey, seven habits of highly effective people. According to people on the internet, I think Stephen Covey stole it for me. Because I quote it so often, people are quoting me, and I'm like, no, it's not me. It's not me.

That's Mr. Covey. Yes. So then we get into the actual advisor. So if neither one of those advisors that he's looking at do I think are appropriate, where do we start? And the big question is it should be comprehensive. Because look at where we started with answering this question. we started with what are the goals that you're trying to achieve and how do we make everything dovetail right because his retirement income strategy is going to affect his defense strategy

his risk management strategy which also is going to be rolled into his legacy planning strategy like those are all part of the same thing and how he answers one of those is exactly tied into the answers to the other ones so i want to make sure that my advisor is looking at how do these investments all work because they're not in a vacuum. And too often when someone is just a wealth manager or just an insurance salesperson, they're not looking at dovetailing the whole thing. I always hate it when an advisor goes, well, yeah, I know you got that other account over there, but I'm not going to pay attention to that.

Are you kidding me? It has 100% to do with my life. So I understand that maybe you're not managing it, but that doesn't mean it doesn't exist and it doesn't affect the outcome, which is where I want to start with my advisor. Beyond that, he asked the question about asset management, whether the advisor should manage the assets or not. Paula, I've got a different answer for him than for 99% of our audience there as well, which is, if he goes to a 1% advisor, I can't imagine an advisor being worth it if I look at $60,000

coming out of your pocket. What's an advisor going to do for me that's going to require $60,000 worth of billable hours? Probably nothing, right? Nothing. But I don't start with that question. I start with what is my end goal and what is my use of time and how do I get there? The majority of our audience is worried about asset accumulation. And the more money I pay someone else for advice that isn't worth it is going to be

friction that gets me to that goal. Eugene does not have that friction anymore. Eugene's biggest issue for me is competent advice, freedom from worry. If he gets great advice around the area of asset preservation and I've got these legacy plans and I want to make sure X amount goes here, X amount goes here and this stuff happens. If a long-term care stay happens, then if I've got a phenomenal advisor. I'm not that worried about the fee as much as I'm worried about what am I getting. There's also a thing that most advisors have, which are breakpoints.

Most of the great advisors, the ones that are true good asset managers, they start off because they know. They know they're like $60,000. What can I do for you that would require that type of fee? So it may start off at a 1% fee, but then you reach a certain net worth that you're having them manage on your behalf, and it goes down to three quarters of percent, goes down to half a percent. So there may be advisors. If you're looking for an asset manager, so you get freedom from worry, Eugene, that will do it for a substantially lower fee and maybe half,

maybe even less than that. But that's the first question, Paula, are you good at what you do? And are you the person that's going to give me the freedom from worry that I'm looking for? And if that's the case, and I've got advisor one charging me 1%, advisor 2 charging me half a percent, well, guess where I go? The tapered fee structure makes a lot of sense. I've long argued that property managers ought to do the same thing. Oh, yeah. Because property managers charge typically a flat fee regardless of the rent collected on the property. So a property manager may do an equal amount of work to,

represent property A, which rents for $2,500 a month, and property B, which rents for $5,500 a month, they may do an equal amount of work on both properties, but they're collecting a significantly higher fee on property B. And that to me has never made sense, particularly because property B likely is in better condition, all else being equal. And better condition means fewer repairs, less maintenance calls, etc. Yeah, the fee's almost backwards in some ways. Right, exactly. It makes sense to have a minimum fee, right, for, let's say, a property that rents for

$700 per month, right? 10% of that, 70 a month, that's maybe too low, right? So it does make sense to have a minimum fee to protect against properties that are too cheap. But then, after a certain point, it seems as though that fee ought to taper down as the rental value goes up. It stands for reason that the same should be true with financial advisors who operate on an assets under management model. What are you doing managing a $10 million portfolio that is substantially more work than a $1 million portfolio? I mean, there may be a little bit of additional work, but I don't believe that there's 10 times more work.

No, and that's why the true pros in that arena have, in my experience, they all have the tapered system. And if they don't, I'm wondering how many people they work with that have your net worth, which should scare you, right? Right. That should frighten me because you're going to have different planning issues. around everything from requirement of distributions to what to do in your non-sheltered accounts, your regular brokerage accounts, you're going to have different investments.

And when you're playing the asset preservation game, you're playing a substantially different game. And an advisor that's not managing money for people that are playing that game. They're managing money for mostly people in the asset growth game, aren't going to have a clue what the right investment strategies are for somebody who's trying to hold onto a portfolio, have it create an income stream, not get text to death on the income stream, and then grow it after all of those things. When we're first starting off, it's good to start off with save here first, save here second. Deal with your risk management situation this way.

You get to Eugene's level, the thing to do is to make sure it dovetails, and that is around what you're talking about, Paula. Thank you, Eugene. Yes, thank you, Eugene. So we're going to get to Nandini's question, which is about where do I save? What accounts do I save into? But first, this word from our sponsors. 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.

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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, a fifth, third better. We're going to hear from an anonymous caller who is wondering, should she sell her condo or should she rent it? Joe, we name every anonymous caller. Do you have a name for this one? I do have someone. I get coaching once a quarter and something as I, you and I talk to because of what we do, we get to talk to very smart people. And it always amazes me that some of the most brilliant people on earth that I talk to, they get coaching from other people.

And I have this amazing coach that I meet with once a quarter. I fly to Chicago and she coaches 35 entrepreneurs in a room. My coach's name is Adrian. And she's incredible. Let's name her Adrian. All right. Great. Then the next question comes from Adrian.

Hi, Paula. I'm looking for help deciding whether or not I should sell or keep and rent my condo in the midst of rising HOA costs. When I originally purchased the condo, I thought it would be a great unit to one-day rent as it is in a very walkable area with a lot of new development, including restaurants and retail. My husband and I would now like to purchase a single family home in late 2024 to prepare for starting a family. but now I am unsure what the best strategy is for our condo. Here are the details. The condo is a 1,000 square foot, two bed, two bath, purchased for 385K at a 3% interest rate. My current mortgage payment is 1420 with 265K left on the mortgage. When I first purchased the condo, the HOA fees were $350 a month,

but now they have risen to $640 a month in 2024. The HOA fee covers water, gas, trash, maintenance, landscaping, snow removal, insurance, and management fees. And almost all of these budget line items have significantly increased over the last few years. Additionally, we had a major plumbing repair, which drained our community reserves and resulted in a small special assessment. So the higher dues are also going towards rebuilding our reserves in anticipation of a boiler replacement in about five years. My neighbor recently rented out a comparable unit for $2,350 a month, including all utilities except electric. If I were to rent my unit out for a similar amount, my cash flow would be very tight based on my current mortgage and HOA plus possible management fees and vacancies. On the other hand,

the current Zillow estimate for my condo is $440k. I am concerned that the rising monthly fee and recent special assessment would be a red flag to any buyers. So I assume I would have to make some concessions and would end up selling a little bit lower. What would you do in this situation? Thank you. Adrienne, thank you for the question. First of all, congratulations on owning the condo. Congratulations on being at the cusp of taking that next step in life. So should you sell or should you rent? Here's what I want you to do in order to answer this question. I want you to open a spreadsheet and calculate something that's referred to as the cap rate. Now, the cap rate

to zoom out and give a framework of what this is and why this matters. I'm going to really zoom out here. Any asset makes money in two ways. There's capital appreciation, which is the rise in value, and then there's the dividend or the income stream that it pays out. So a share of Coca-Cola stock, for example, hopefully rises in value over time, that's the appreciation, and also has some type of a dividend payment. A house or a property,

in your case a condo, is no different. The condo has some level of appreciation, and it also has a dividend or an income stream. Now, what you want to do is you want to figure out what that dividend or that income stream is. And so the way that you calculate that number

is first you calculate all of the revenue that your particular condo could collect. So the rental income, I don't know if there's a parking spot associated with that condo, but if you charge extra for the parking spot, that would be additional income as well. Any income, if you charge a pet fee, if you decide that you're going to charge maybe an extra $50 per month as pet fee, layer that in. So first project all of the revenue, not just the base. rent, but parking fees, pet fees, laundry fees, maybe the building has a separate storage unit and you would charge for access to that, any and all revenue, right?

Calculate all of that together. That is the potential gross revenue that you could collect. Then you start subtracting all of the expenses. So subtract estimated vacancy, subtract out estimated repairs, maintenance, CAPEX, the HOA, subtract all of that out. What you're left with is a number

that is called the net operating income. Now, the one thing that you are not subtracting, let me make this very, very clear. The one number that you are not subtracting out is the principal and interest portion of your mortgage payment. That does not go into the formula. And we'll talk about why in a moment.

you will subtract out the insurance costs on the condo. You will subtract out the property taxes on the condo. But the financing, the debt financing, the principal and interest portion, that does not get subtracted. So you take the revenue minus operating expenses equals net operating income. Net operating income divided by the purchase price of the property, the price that you paid for it, that number expressed as a percentage is your cap rate. Now, the reason that you want to calculate this cap rate is because you want to find out what type of unleveraged return you would be getting on this condo.

And to figure out that unleveraged return, you look at the cap rate. That cap rate is the equivalent of the dividend that you are collecting. And that dividend plus your estimate for capital appreciation, those two together constitute your total return. So, for example, let's say that your cap rate ends up being 5%. And you also estimate that over time, the condo will rise in value by, we'll say, 4% per year. That means that your unleveraged total return would be 9%. That would be 5% as the dividend that you're collecting, plus an additional 4% as your estimate for appreciation.

There will likely be a range. As you're making these estimates, you're going to estimate a range for what you think the repairs, the maintenance, the capital expenditures, the vacancy, possibilities for capital appreciation, maybe 3%, 4%, 5%. Don't conflate precision with accuracy. You might calculate a worst case, best case, and medium case scenario. But you want to calculate this range of what you think the unleveraged return will be. And then take a look at that return and ask yourself, is that a return that I want relative to the amount of risk that this condo carries? And when I say risk, I'm talking about the risk of vacancy, the risk of high levels of turnover, the risk of multiple calamitous repairs and quick succession such that the CAPEX becomes greater than your cash reserves can float. Those are the risks that you face. So what are the returns relative to the risks? And based on that, you know whether or not this is an investment that's worth holding. And you'll also know whether or not it's worth borrowing money at whatever percentage your mortgage is. You'll also know whether or not it's worth borrowing money at X percent in order to obtain a total return of Y percent.

right, but you need to calculate cap rate in order to answer those questions. Fabulous. I love any time that we'll make these decisions based on math. It's truly an emotional place where you are. I have this condo. A lot of people answer that through an emotional filter system. Right. Right. Exactly. And, you know, with something like the HOA fee, right, that is a much maligned fee. People hate paying high HOA fees, but you never hear the same level of discussion about the fact that, as she stated in her question, the fact that people who own single family homes that are not HOA governed, so homeowners who do not have HOA fees, they often pay higher property tax rates, higher insurance rates, higher water and sewer.

Right, water, sewer, trash, electricity. Exactly, exactly, right? Those fees go up. One thing that I want to applaud Adrian for is that in her question, in the way that she talked about the HOA fee, it's clear that she understands that the HOA fee rose is because it covers all of these costs that have risen. Many other people out there in the world, unfortunately don't, because it's very easy to just look at an HOA fee and say, wait a minute.

What does this rip off? Yeah, my building doesn't have a pool. What does this cover? You know, like forgetting about all of the invisible costs like sewer. It seems like you might be able to know if you're HOA fee, if they are taking maybe more than what you would want by looking at comparable people in the neighborhood. Because I believe if it's a municipality that's managing these systems, I should be able to know what these individual rates are and do kind of another back of the envelope calculation.

Right. But in a condo building, you also have common areas. There are elevators that need to be maintained. And when you get out of the elevator, there's a hallway. And that hallway has to be air conditioned. It has to be heated. It has to be cleaned. It has to be occasionally repainted. It has light fixtures that need to be changed out. I'm not saying it be one to one. I'm just saying I can list these things that I get for myself. And then I can think about those common areas and whatever and go, okay, yeah, yeah, I can, I can totally see this fee. Or I can go, what the heck? And then I've got some interesting questions to ask the homeowners association, you know, how does this break down? What's this for? Well, HOA has always published their budgets.

Any homeowner who pays an HOA fee can get a copy of the HOA budget. So you don't even have to do the math. You can just ask for a copy of the budget. Even easier. As much as people like to fixate on HOA costs, people often don't give that same level of attention to utility costs. And utility costs rise. That's just what they tend to do over time. You heard it here first, people. Adrian, to go back to your question, calculate a range of cap rates, calculate a worst, best, and middle case scenario based on your assumptions around all of

these various operating expenses, and then add that cap rate to your projection of how much you think that the property value will rise through market-based appreciation. And that's your unleveraged total return, which is just a fancy way of saying, if you held the place in cash, if you held the place free and clear, that's what the return would be. And by the way, the reason that I'm saying that, you know, you said something in your question that raised a little bit of a red flag for me. It's when you said that your cash flow after paying your mortgage and everything would be negligible.

Obviously, you want the cash flow to be positive. A lot of investors set a goal of $100 per door. For a lot of investors, that's their goal when they're going out and trying to find a property. And that's because they understand that a lot of the return comes from principal paydown. You're getting tenants to pay off the mortgage. therefore you're growing equity and growing your net worth, and that's coming out of the rent that you're collecting, you are getting over time higher and higher rent.

Rent tends to rise at the rate of inflation, but your mortgage, if it's a fixed rate mortgage, stays the same. So that delta increases over time, right? So you're getting increasing revenue on fixed debt. debt on a fixed debt expense, right? Like, investors understand that the financial benefits of owning a rental property are not necessarily reflected in the cash flow in year one. Cash flow in year one is a very negligible part of the overall benefit, the overall

return that you get on a rental property. And that's the reason why calculating the cap rate is a a much better way of understanding what kind of return am I actually getting? What kind of return does this asset yield if it were to be held free and clear? And once you know that, then you can decide, does financing at this given interest rate justify this other given return that I'm receiving? By the way, notice the thing that I'm not talking about. I'm not talking about, there's a different formula. It's called cash on cash return. This other formula is very popular among real estate investors, I do not like it because the formula cash on cash return is designed

to reward maximum levels of debt. Leverage, yeah. Yeah, exactly. The formula of cash on cash return asks the question, what kind of return am I getting relative to the amount of my money that I've put into the deal? I hate looking at it like that because when you look at it through that framework, you are necessarily setting yourself up into a question that. that rewards putting the least amount of your money into the deal, meaning borrowing the max, right?

If you put $0 into the deal, your returns would be infinity. And you should be inherently suspicious of any formula that tells you that your returns are infinity. So I am not a fan of the cash on cash return formula. I'm a huge, huge fan of the cap rate formula where you understand, if I held this free and clear, what would the returns be? and you can evaluate the asset itself absent of any financing considerations, right? And once you know that the asset itself is a good deal or a bad deal, meaning does it have a good risk-adjusted return or not, relative to the amount of risk that that particular asset holds, vacancy risk, tenant risk, etc., then you can make a financing decision. But I like the idea of evaluating the asset itself inherently first before you then turn your attention to financing. That's the reason that I'm a huge fan of cap rate and also the reason that I despise is maybe too strong of a word, but really, really dislike the cash on cash return formula.

So, Adrian, there's your answer. Tadda. I couldn't have said it better myself. You ran with Eugene's question about insurance products and insurance products and. choosing a financial advisor. So it was my time to run with Adrian's question around, should I sell or should I rent? Yeah, I feel like we're handing off the baton today. And when I say, I couldn't have said it better myself. I totally mean I couldn't have said it. I couldn't have said any of that. All right. Well, thank you, Adrian, for the question.

Joe, it's time. It's time for the question that we have been building to. The featured question. featured, today's featured question. And this question comes from a listener who saves $5,000 per month after taxes. And she wants to know, how should she invest this money? What accounts should she put this in? Where should this go? This caller, her name is Nandini. Let's hear her question.

Hi, Paula and Joe. My name is Nandini. I really enjoy listening to your podcast. and recommended it to so many of my friends and family. As an immigrant, I was struggling to understand even basic things in financial investing, and your podcast helped me a lot. My question today is my husband and I saves roughly about $5,000 post-tax per each month. I'm looking for ways to invest this money.

We don't have any kids yet. We both are currently doing employer match for 401K, max out our HSA, 10% of our salary for ESP. We also max out backdoor Roth IRA. The only debt we have is home mortgage, which is 390k with 3.8% interest. We also have a cash of 50k in high-yield savings account with 4.3%. Here are some investment options I thought about. Since we both are not maxing out our 401k, and we do have both traditional and Roth 401k options. So the one way to invest is to maximize our 401k. Our companies also offer mega backdoor Roth with the limit of 44K.

The second option is to invest in index funds or mutual funds, but since we both are very busy and not able to spend a lot of time in research of funds, we are thinking of picking some easy index funds like SMP 500. and invest monthly. Apart from these two options, can you think of any other suggestions? I appreciate both of your valuable input on this. Thank you.

Nandini, thank you for the question. This is such a good question. And I want to take a moment to expand this to everyone who's listening because fundamentally your question is, I'm saving money. Where should it go? I'm saving money. Should it go to a 401K?

should it go to a mega backdoor Roth, should it go into a taxable brokerage account? So much of personal finance fundamentals focuses on the step that you're already doing, which is saving. And by saving, I mean having a gap between what you earn and what you spend, right? You're already saving $5,000 a month. You've got a gap of $5,000 a month. You've got a gap of $5,000 a month between income and expenses.

Fabulous. Right? That is incredible. That is so great. So much of personal finance focuses on encouraging people to do that without ever addressing the follow-up question of what do I do with that money. That's why I love your question. So let's talk about what to do with that money.

First of all, you're maxing out your health savings accounts. Both you and your husband are maxing out your health savings. accounts, incredible, amazing. Keep doing that. Don't stop. The reason for that is because health savings accounts, HSAs, have a triple tax benefit. You get a tax benefit on the money that goes into the account. You get a tax benefit on the money while it's in the account, and then you get a tax benefit on the money when you spend it. So triple tax benefit, health savings accounts are absolutely fantastic. Love it. The next thing that I would say is a, a lot of love the fact that you are totally debt-free other than a mortgage that has a very, very

reasonable interest rate. I love the fact that the money in your high-yield savings account is earning an interest rate that is higher than the interest rate that you're paying on your mortgage. How cool is that? Like, money in a savings, can we pause and think about what that means for the society that we live in? What that says about how quickly inflation has risen and how quickly interest rates have gone up as a result, that a person can have a mortgage rate, a fixed rate mortgage that is at a lower interest rate than the money that's in their savings account, right? Wow. Like, and I'm sure that there are thousands of people who are listening to this who are in the same spot where money in your savings account, money in a high

old savings account, is making money at a higher rate than your mortgage interest rate. It's incredible. It's a strange time in history. Yeah, it is. It is a unique time in history. What I would recommend for you is to maximize any type of a Roth account that you can access. So you talked about two different types. You said that you have access to a Roth 401k through work and you also have access to a mega backdoor Roth.

Also through work. Yeah, also through work. I would put as much money into Roth accounts as possible. And the reason for that is, although you do take the tax hit now, all of your gains, your capital gains, your dividend income, every gain grows tax-exempt. And if you think about the power of compounding over the decades and the power of growth over the decades,

that is an incredible amount of money that grows tax-exempt. exempt. So the more money that you can put into a Roth account, assuming that that money is invested for the long term, that that money is going to be there for decades and decades to come, you pay essentially a small fee right now, that fee being your current this year's tax bill, in order to have decades and decades of tax exempt growth. It's an incredible opportunity. So make the most of that. I love the bias toward the Roth. And I love that that second piece after the HSA is 401K. And I also like that for people starting out to the employer match because if you're just beginning, the employer match is it's free money.

And even if you have goals that are different than for retirement, I would never give away free money. So always put money in the 401k up to the employer match. You're going to need that money anyway. If you have any type of financial independence goal, it's a great idea to backfill, meaning look at the later years of your life first and make sure you're going to be secure in those later years. So if you're in your 20s, you're starting out, let's make sure you're going to be fine in your 90s. Let's put some money toward that so that your freedom from worry, you're able to move forward. And then over time, then it'll be that you're safe in your 80s, then your 70s, then your 60s, and hopefully your 50s that you're safe, right?

But I like this idea of backfilling because the more you have a bias toward not just the Roth, but also toward your long-term goals versus the short-term stuff, then your money gets to work for you. I think I first read about this in Rich Dad, Poor Dad, Paula. the idea that your money is like another you that takes its lunch to work every day. And I get really excited about that analogy because I'm as lazy as the next person. And if I can skip work on a day, but my money every day goes to work and works and makes money on top of the money. I mean, that's fantastic.

So the quicker I can get my money earning a living wage, the better. And I love that. And that's why I like backfilling those. So my bias, I have two biases in my order of operations. Bias number one is emphasize long term over short term. Bias number two then is if I'm going to use debt, I'm going to try not to, but I'm going to more likely think about debt to fill in my short term things than I am the long term stuff. In other words, a lot of people will make sure that their kids college fund is saved for before they get themselves to financial independence. I look at that the opposite way.

I think, Paula, you look at that the opposite way. There are plenty of ways to get junior or yourself through college. Some of them involve debt. There is no loan program toward financial independence. So if I'm going to go into debt, it's going to be for some of the shorter. term stuff. This is really important though, Paula. And I think it's it's because of the fact that just as humans, we tend to look at the next thing coming up and we want to make sure we're going to feel okay when we get to that moment. I love using the psychology of imagining myself being 65 years old

and I haven't done a thing for those long term goals. I let myself feel that feeling. And when I feel that little bit of fear, I'm not really fear motivated, but when I feel, when I feel that, that little bit of fear, it helps me get beyond this short-term problem that I'm experiencing that I want all my money to go towards so I feel okay today and instead put me in a spot that makes sure that I'm going to feel good later on. You know, there are apps where to the to the point of imagining that you're 65 and imagining what the 65-year-old version of yourself would want the you of today to be doing. there are these apps where you can digitally age your face.

And there's actually research that shows that people who do that save more money for retirement. If you can imagine yourself in retirement, which you can do by seeing a picture of your digitally aged face, then you have a visual image of the person that you are saving for. after those basics then i think we get to uh your goals and if you begin with the end of mind we can then build a plan that is based on how much money does each goal require and we're never going to know exactly right things are going to change the goals are going to change and that's why we call it planning and not a plan a plan is worthless the second it's printed but the idea of planning as you go is going to help you move as the river moves, you're going to flow like the river. So whether you put money in non-IRA positions or in the 401K are going to be based on how

many goals you have before you can get at that 401k slash IRA money. We want to have some flexible money so that you're able to save for those separately. So if it's a new home, if it's some goal to take more time off work to do the things, take a sabbatical. Certainly, I wouldn't put that money in your 401K. I wouldn't use 401K loans at all. I'd stay away from those. Those are nasty for a variety of reasons. But I think that that bias toward the Roth, bias toward long-term,

and then once you do that, HSA, Roth, long-term money, take the match, then look at your goals and now put money in the appropriate pots. I'll say this too specifically about what Nandini was talking about, which is I wouldn't even look at the mega backdoor Roth option through work until just the straightforward Roth 401K is fully funded. Because Paula, that money's all going toward the same pot and it's so much easier to not have the two or three steps to get the mega backdoor Roth where you wanted to be versus just max fund the Roth 401K.

I see people do backdoor Roths often when they have the Roth 401K available and they're not max funding the Roth 401K and they're going through all these tax gyrations. Max fund the Roth 401K first. It's just going to make your life a ton easier. So Joe, you never did answer the question. What accounts do you save in first? Ah, I save specifically into pot based on what the goals are. So we save into Roth 401K.

I do not have an HSA available. You've got one of those good health insurance plans. Right. Low deductible. Yes. We do. Ragger. I feel very lucky there.

Save into the Roth 401K first. Then I save into a variety of, of non-IRA spots, but I save specifically Paul for the goal. So I have a fund for my next car. I have a fund for home improvements. By the way, I use an ally bank savings account. This is not, there's other companies that do this. But I like it that I have one high yield savings account like Nandini has, but I have separate buckets inside of the same high yield savings account. And Cheryl and I can put names on it. This is the car money. This is our money for our home edition. This is This is money for next year stuff.

So all the plans that we have are separated so that I'm not spilling over into a different bucket. Behaviorally, I love that. And then it does make sense. Every account that you choose would be tethered to a given timeline. And then it makes it easy. Then much like Nandini, I pick the index that fits the goal. It's super easy. And by the way, Nandini, that's the perfect way to do it.

When you say don't have a lot of time for research, the only thing. thing you need to research is what's the amount of money I need to reach that goal and which index is the appropriate place to get me there. Period. Full stop. Yeah, exactly. In fact, it's not even what index, but just if you want to keep it super simple, one total stock market index fund, one total bond market index fund, then the only question is what proportion of each one fits this particular timeline. If you want to make it super simple, just do that. Yeah, good night.

Right. Well, speaking of good night, I think we've done it again, Joe. No, say it ain't so. It is so. And Nandini, thank you so much for the question. Joe, where can people find you if they would like to hear more of you? You can find me and sometimes the amazing Paula Pant. Usually I'm Fridays with Paula.

Monday, Wednesday, Friday, though, for me at the Stacking Benjamin Show, which we call the greatest money show on earth because on Mondays we have great mentors. On Wednesdays, we dive into one or two very specific tactics. And then on Wednesday, we have a wonderful roundtable discussion with Paula Panthe, award-winning Len Penzo and a, what would you call it, a turnstile of interesting guest on a roundtable. A rotating cast of characters. Of characters. And usually very knowledgeable characters that we've curated to duke it out with Paula and Len and OG.

And you recently aired a couple of weeks ago, you recently aired episode 1500. So while we over at Afford Anything, we're celebrating episode 500, which is coming up next week. You guys just celebrated episode 1500. I wasn't going to bring that up. for the math majors here. That's three times more. It's funny because we have had a lot of episodes, and I feel very grateful for this community.

There's a guy that I know who Glenn Heberts, his name, Paula, he runs the horse radio network. They go five days a week. And when he heard we were on episode 1500, he's on episode like 4,000. He's one of the few people. that can go, oh, how cute. He literally said, Joe, that's so cute, 1500.

Good for you, beginner guy. That's funny. Isn't there some statistic? Most podcasts fade after like episode. Jeez. Seven. Wow. People discover how much work it is.

And then they're like, nope. They just nope out of that. It blows me away how much work it is. Doesn't it blow you away? It's great work. I love it. But there's a lot more behind the scenes than. anybody would expect.

Yeah, absolutely. But I am, like, thrilled that you hit episode 1500 and we hit episode 500 in the same month. So April 2024 was the month of afford anything episode 500, stacking Benjamin's episode 1500. I feel like there's got to be some, you know, the stars aligned. Well, you're celebrating at a comedy club. And I said this before we started. We did our comedy club tour.

So again, Paula, how cute. for our episode 1000, we celebrated with a lot of different podcasters and heard from a lot of different voices from the personal finance community, which I was grateful for. This 1,500 people want to go back and listen. You, Len, and O.G, and Doug and I just talk about all the years of Stacky Benjamin, some of the funny stories from the past. and we have stackers that call in and that have called in and tell us how their life has changed because they've listened. So we go back and forth between the history lesson of how was the show made, how has it changed, you know, a comedy of errors that we've done along the way and just all along the way

how hopefully, you know, much like the Afford Anything show that we're hopefully helping people change lives. Well, I would love to hear from Afforders. Afforders, please call in and tell us, affordanything.com slash voicemail. Call in and tell us what the show has meant to you. And we will, well, we've already recorded episode 500, so it won't air for that episode. But I would love to play that on a future episode. All right.

Well, thank you so much for tuning in. This is the Afford Anything podcast. Make sure that you're following us in your favorite podcast playing app so that you don't miss episode 500. And I'd like to give a warm embrace to. Episode 499, which is this one and all of the 499 episodes that have come before it. Goodbye to the 400s. It's been amazing. It's been real.

So excited to enter into the 500s. Again, make sure you're following us in your favorite podcast player. While you're there, please give us a rating and a review. Recommend us to your friends. And I'll see you next week. I'm Paula Pan. I'm Josal Siha. And we will catch you in the next episode.

Because one of our callers has that exact question. Where should, where should, where should she save first? That is really hard to say. Where should she? Where should she? If she shave she sells, somebody's shore. Worcestershire. Worcestershire.

You know, the sauce, the Worcestershire. Worcester. Worcestershire. Worcestershire. Where should she she she first?