Real Estate Switching Costs

Real estate has had a good run since 2010.

It can be tempting to cash in profits.

Financial Case Study

My neighbor is just about at the point where he can net $1,000,000 dollars on the sale of his house. He’s retired and this represents a very substantial sum for him. One million dollars is also kind of a magic number emotionally as he never expected to be a millionaire.

For him to net $1,000,000 he will need to sell his place for about $1,067,500 gross.

He bought the house many years ago so, even after his primary residence exclusion, he’s going to have a tax bill of $70,000.

There will be other costs (moving, cleaning, etc…) adding up to $2,500.

So his certain costs today are $67,500 + $70,000 + $2,500 => $140,000

Putting this into his personal context…

Having paid off his mortgage by the time he retired, he has the ability to live on $1,500 per month. So he’s looking at a certain bill that’s worth 7 3/4 years’ living expenses.

He’s also a young retiree, with parents still alive.

So he might be living another 30+ years.

Key Questions

How might the switch make things better? Whatever they are… they are uncertain benefits to be weighed against certain financial costs.

How will surplus cash be invested? Given the choice between prime residential real estate and an investment account… most retirees prefer the hidden volatility of real estate.

Do I want to leave my community? When I left Christchurch (NZ), I left behind a fantastic group of people. Community has a far stronger association with a meaningful life than cash in a bank account.

Certain types of people make new friends easily. I’m not one of those people! What type of person are you?

What Can Go Wrong

Bull Markets — Assume that you can only “move out of town” once. In our case, we lack the financial resources to repurchase our existing real estate at current market prices. If we sell, and prices rise, then we will be priced out of the market.

Neutral Markets — Real estate is expensive to transact. In the example above, the vendor is paying 13% of gross proceeds in commissions, taxes and expenses. In any new purchase I assume that I “lose” (on paper) 10% of the gross purchase value at completion. In other words, I am going to need a 10% market increase to get my money back.

Bear Markets — Can I afford to be locked into this market for many years? Vacation markets, cities reliant on a single industry (oil and gas) and secondary locations… buyers can be locked in for five plus years. Am I OK with that risk?

The Good Enough Portfolio

There’s a lot to be said for an attitude that an existing position is “good enough.”

Each time I make a choice, change or modification it’s an opportunity for expense and error.

 

Regime Change

2016-11-24-19-02-19A friend asked for my thoughts about “what he should do” regarding the changes that are about to happen within the US Government.

My quick answer was “do nothing.”

2016-11-25-16-16-29..but there is a lot we can do.

I spent the days after the election teaching my kids to read, helping with math and working on the family’s open water skills.

My advice to “do nothing” is based on the following…

#1 – if you are adjusting strategy more than once a decade then you don’t have an effective strategy // if you truly feel the need to change then there is a structural problem within your family plan

#2 – you should consider tweaking strategy when your life changes (not the ruling party) – unemployment, impending retirement, new dependents, less dependents, major illness, wealth transfers // external surprises are going to happen all the time — spend your emotional energy preparing yourself to stay-the-course, not feeding your fears

#3 – the best time to sell high-quality assets is “never”

2016-11-25-16-31-59#4 – all the emotional energy and financial wealth spent on elections is better allocated to the next generation of your family

#5 – the richest people in America are about to feel a whole lot richer // stay invested and, if you sell to rich people then, raise your prices

#6 – with Elaine Chao’s appointment, the pieces are falling in place for a major domestic infrastructure initiative — this strikes me as a whole lot better (for everyone) than nation building via Asian land wars

#7 – don’t build capacity, or leverage, to the peak // the next recession is likely to be large

#8 – there will be excellent buying opportunities in all our futures // I’ve been researching my next major purchase since before the last recession

2016-11-26-10-29-40The hive-mind has been wrong all year. Glaringly wrong!

I ask myself, “Have they ever been right?!”

Spending time infecting our minds with media noise is the worst thing we can do for clear thinking. Turn off the media, learn persuasion psychology and study history.

Know that the largest gains in your family’s human capital come from self-improvement, ever stronger marriages and educating the next generation.

  • Financially – stay the course
  • Individually – incremental positive change

2016-11-25-16-33-30

Financial Planning for Long-Term Success

2016-09-07-12-05-16November 1st is the start of open enrollment in the US healthcare sector. To celebrate, Unitedhealthcare notified me that my premiums are heading up by 25%. I wonder how the total compensation (salary, bonus, private jets, security, stock) of their senior people will compare to the next president’s cabinet?

I overreact to unexpected, but manageable, loses.

Perhaps you are the same?

2016-10-14-17-33-43It takes effort to make myself more rational, and avoid exposing my family to unnecessary suffering. Here, I include loss of happiness from worrying about the small stuff.

The antidote is to always frame negative surprises in the largest possible context.

Our premium change is…

  • …less than 1% of the increase in our net assets over the same period
  • …less than 0.25% of my family’s net worth
  • …less than 5% of my family’s core cost of living

The premium shock motivated me to take a deep dive into family assets, liabilities and expenditures.

We measure core cost of living in terms of healthcare, total taxation, education, food and housing (mortgage, taxes, insurance).

Our key discretionary items are childcare, vehicles, vacations, college funds and gifting.

2016-10-14-14-56-00When you’re looking at a budget, or a business, go deeper and consider…

  1. Sources of large changes in income // unemployment, vacancies, new initiatives
  2. Sources of large increases in expenses // lease rates, insurance premiums, tax rates
  3. Prudent future planning // long lifespans, persistent lower investment returns

What can go wrong? What can we do, when inevitable shocks arise?

What can go right? How can we increase our exposure to large positive outcomes?

  • Children
  • Education
  • Capacity to help others with high-value work
  • Equity investments
  • Voluntary simplicity – our greatest wealth creator

2016-10-15-09-42-33While no one can predict the future, the 30-year bond (2.5%) is indicating that prospective returns are likely to be less than any of us have seen across our adult lives.

Historically, financial freedom targets net assets equivalent to 25 years of core cost of living. While that might be true historically, have a careful look at your joint life expectancies and quantify your longevity risk.

Young couples need to consider 50-year retirements, with 0.5-1.0% real rates of return (before taxes, fees and expenses).This possible outcome is far different than what I was taught in school, or even considered five years ago.

High Finance

2016-09-24-10-14-55Keep your ears open this week. There will be a rare opportunity to learn about finance.

For my international friends, many of the American techniques (in the news) are available in your home countries. I have been applying finance, across four continents, for more than 25 years.

2016-09-25-18-48-42The overall financial system works great. However, when I try to explain certain shortcomings to my friends, their eyes glaze over and I lose them.

I wish I was more skillful.

Whether your favorite billionaire is a Cuban, a Koch, or a Buffett, we can learn a lot from insiders. A constant refrain from wealthy insiders is “complexity creates opportunity for the system to be gamed for economic benefit.”

Finance is a complex system. The system has been gamed extensively.

  • Offshore accounts (Panama Papers type stuff)
  • Thinly-capitalized investment vehicles, with lots of debt
  • Applying non-cash losses today, while deferring cash gains to tomorrow
  • Receiving preferential tax rates on gains associated with financial work
  • Using trusts to avoid estate and generation skipping taxes
  • Using special accounts to shelter income and gains across generations
  • Income reclassification to avoid income and payroll taxes

If the collective wants to run the system like that then I’ll bow to its will. However, I’m not sure the collective knows what’s up.

2016-09-28-10-43-49-1Like professional sports, my beef isn’t with the system. What irks me is the lack of integrity when insiders pretend the system is different than reality. The politics of the people I named above are different but their observations are often similar.

I’m grateful I can explain my personal reality without fear of banishment or loss.

Living a life you can disclose saves a lot of suffering.

Wisdom

2016-06-20 09.38.59Last month, Dr. John wrote an excellent blog about medical wisdom. I’d urge everyone to read it. I took that post one step further and read Ending Medical Reversal, which was recommended in the article. If you want to make better life decisions then you need to make time to read and consider the book. At a minimum, ensure that the book is read by a leader within your family, firm or practice.

Aside from the specific examples, which are fascinating, I hope you take the following away from the book.

2016-06-18 08.42.46-2HUMILITY – medicine is a global field where we have tens of thousands of our brightest humans spending trillions of dollars. The book makes are strong case that 30 to 40% of that expenditure provides no net benefit to humanity.

The authors lay out numerous examples where billions are blown for no net benefit. It is a wonderful reminder of our shared capacity for irrationality and misjudgment.

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2016-06-18 08.44.11PARACHUTES – one of my favorite parts of the book is when they explain that there aren’t a whole lot of parachutes left in medicine.

What does this mean?

If all of humanity has to jump out of an airplane then nearly all of us are all going to do dramatically better if we’re giving a parachute.

A parachute is an intervention with big positive outcomes for a large slice of the population.

What are parachutes that you can apply in your life?

They probably include items like: exercise, germ theory, antibiotics, vaccines, not smoking and seat belts. In a capitalistic society, there’s a clear role for government to play in keeping society focused on the big ticket items.

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2016-06-18 08.33.54EXPECTATIONS – let’s say you do your part and follow the “parachutes,” what’s a reasonable expectation from modern medicine?

Keeping in mind that 30-40% of modern interventions are bunk, I was left with an expectation that most procedures will usually make most people a little better.

That’s it.

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If we have the courage to consider:

  • widespread error
  • limited number of high-value options
  • realistic expectations

then we might find that there are new resources to focus on parachutes in other areas of our society. The cost of the status quo is often hidden from view.

There are plenty of good ideas: universal basic health services, early-childhood programs, pre-K, drug treatment, parent coaching and financial literacy training (see Kristof at the NYT). Other authors prefer infrastructure projects.

Whatever your preference, it’s clear that uninformed choices can waste valuable resources.

 

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A final note about change.

Even clearly harmful treatments can take a decade to exit the system (plenty of examples in the book). Strangely, I took this as a message of hope.

You might not be able to reform the healthcare system but you can certainly make better decisions within your own life.

Keep at it.

Ultimately, the truth wins.

Breaking Down Family Risks

2016-06-09 17.39.38In May, I wrote about a misplaced sense of entitlement being our family’s greatest source of loss.

There are two components implicit in the article’s discussion of loss.

#1 – permanent loss of capital

#2 – loss of purchasing power over time

A wise advisor will keep these two factors front and center when discussing the risks associated with your assets, income and spending.

Unfortunately, wise counsel runs counter to human nature which likes to discuss…

Prediction of the future – we love stories about how our decisions will do better than other people’s decisions.

Fear of price volatility – nearly all price movements represent noise that can be ignored.

Two phrases for you to repeat daily….

No one can predict the future.

Volatility is not loss.

2016-06-09 21.25.10Instead of scaring yourself witless with the news, do something useful.

Turn your electronics off (ideally, for a week) and consider…

#1 – Where is the family exposed to permanent loss of capital?

#2 – Does our life situation protect us from the loss of purchasing power over time?

Consider further…

#3 – Where are our uninsured catastrophic risks – health, life, fire, earthquake, flood, asset concentration, counter party, addiction, fraud, abuse…

#4 – What is our ratio of net assets to core cost of living – how many years, months or weeks do we have?

#5 – What is the ratio of net assets to actual annual spending – most families have significant discretionary spending that can be cut in crisis. If necessary, do we have the ability to change and extend the years, months and weeks of cushion?

#6 – What percentage of our cost of living is covered by passive income (rental income, dividend income, interest income)? How does this income change over time?

a – rental income // an indexed source of income based on local economic growth, there’s also a potential capital gain associated with the land value, However, there is the potential for vacant periods as well as the need for occasional large investments with the building

b – dividend income // in a low-cost index fund, this source will be indexed based on national/international economic growth. There’s no potential for capital calls and you will have the ability to sell in small increments

c – interest income // this is fixed source of income, where the best you can do is get your money back at the end of the loan period.

If you put a number beside each of a/b/c and lay out your other sources of income (employment, pension, social security, partnership) then you will see how you are funding your annual spending.

Most families will have concentration in income, as well as assets. Concentration is a source of risk.

Are we acting on the right things?

Change slowly.

 

 

Family Investment

2016-05-29 16.30.07Having worked in finance, and coached the triathlete demographic, I know people with a lot of discretionary income.

I have three kids and the way we allocate income has changed significantly over the years. Here’s a current snapshot.

family_spend

The marriage/kids slice (blue) is about half our spending. What the heck is in there?

  • Sitters and Live-In Au Pair
  • Preschool Fees
  • House cleaning
  • After school activities
  • Summer activities

With minimal psychological maneuvering it would be easy to shift the marriage/family allocation towards myself.

My wife arrived into our marriage with an expectation of driving herself straight into the ground to “support the family.” Her story is repeated across a range of households.

It is tempting to compromise our marriage for short-term savings.

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I like to invert the temptation and ask myself…

How do my spending choices benefit my marriage?

What about my health?

Consider…

A – collectively, we see no issue with parents torching their physical, and mental, health to “support” the family. Among my peers, the easiest way to get time alone is by working full-time. Double income, no time.

B – couples are often blind to the price the marriage is paying from being completely fried. The baby/preschool years will end up being a decade for us (2008-2018). Do you have enough passion in your life?

C – my spending places the highest premium on buying time

  1. time exercising – to maintain my physical health
  2. time alone – to maintain my mental health
  3. time with my spouse – to share experiences

My wife often feels uncomfortable with our childcare spending. There is tremendous social pressure for a mother to follow a path of doing everything.

Buying time is insurance against the risk of arriving at 50 overweight, mentally fried, with a marriage in need of counseling and an oldest heading into middle school with an angry (or absent) father.

Trade money for time.