9. Invest in index funds or real estate (or crypto, I guess)

If you're at the point where you have fully funded all the previous steps and you still have money to play with, then start investing it further to build wealth.

 

Reasons           

 

Congratulations!

• There's not much to this, so I apologize in advance for the oversimplification.

• The truth is, if you are this far into the guidelines, then you should feel very proud of yourself.

• Additionally, these strategies are VERY specific to the client, so it is relatively tough to provide general guidelines here.

• Instead of talking strategy, I'll just provide some overview of each investment style above.

 

Index Funds

• Definition: An index fund is a type of investment fund that aims to replicate the performance of a specific financial market index, such as the S&P 500.

• So, what the hell does that even mean? (if you do, then I'm proud of you).

• Let's start with the basics - what is a stock (also known as a share)? 

  • A stock is something you can purchase (i.e., the Stock Market) and it gives you "ownership" in that company. 

  • With this ownership, you share in the ups and downs of the company - the better it does, the more the stock goes up, and the worse it does, the more the stock goes down.

  • Real like example -> You buy 1 share of Nike stock for $100; if Nike does well and the stock goes up to $105, then you just made $5. If the stock goes down to $95, then you just lost $5. 

  • However, it is extremely difficult to know what companies will perform well and which companies will do poorly. Therefore, it's much safer to buy stocks across multiple companies (and industries) to spread out this risk, aka "diversify".

  • But if 1 share of Nike costs $100, 1 share of Apple costs $200, and 1 share of Amazon costs $1,000, then this can get VERY expensive. So, how can we diversify and not go broke?

• The answer, as you may have guessed, is index funds.

• Index funds, as mentioned above, aims to "replicate the performance of a specific financial market" (i.e., the S&P 500). In basic English, an index fund picks a market and copies it.

• Let's take the easiest and most widely known financial market - the S&P 500. This is the top 500 companies in the world (again, in the most basic of terms).

• An index fund will replicate the S&P 500 by purchasing shares in these 500 companies. As the S&P 500 goes up, the index fund performs better, and as it goes down, the index fund goes down.

• So, all you have to do to diversify is buy shares in the index fund and you will follow this same trajectory.

• It is also much more cost effective to buy shares in an index fund. I've provided NerdWallet's Top 5 S&P 500 Index Funds. 

• This is a very basic overview. Here are some other facts for you:

  • Passive Management: Unlike actively managed funds where fund managers select stocks, index funds are passively managed, meaning they automatically follow the index they are designed to track.

  • Replicating an Index: The fund buys all or a representative sample of the securities (like stocks or bonds) that make up the index.

  • Low Turnover: Because the fund mimics an index, there’s little buying and selling, which keeps costs down.

  • Market Diversification: By investing in an index fund, investors get exposure to a broad range of companies or bonds within the index, reducing the risk of any single company or bond performing poorly.

  • Low Fees: Since index funds don’t require active management, they usually have lower expense ratios compared to actively managed funds.

  • Simplicity: Index funds are easy to understand, making them a good option for beginners.

  • Consistent Performance: Index funds aim to match the performance of the index, which often results in steady, predictable returns over time.

  • Diversification: Investing in an index fund spreads risk across many assets, reducing the impact of any single asset's poor performance.

  • Some risks:

    • Market Risk: Index funds are subject to the overall market's performance. If the market index falls, the value of the index fund will also decrease.

    • Lack of Flexibility: Since index funds strictly follow the index, they can't adjust to market conditions or invest in opportunities outside the index.

    • Tracking Error: There might be slight differences between the fund’s performance and the index due to fees or imperfect replication of the index.

  • How to Invest in Index Funds:

    • Through a Brokerage Account: Investors can buy index funds through an online brokerage account, either as mutual funds or exchange-traded funds (ETFs).

    • Minimum Investment: Some index funds may require a minimum investment, but ETFs can often be purchased for the price of a single share.

    • Regular Contributions: Many investors contribute to index funds regularly, like through a retirement account (e.g., 401(k) or IRA).

  • Key Considerations:

    • Time Horizon: Index funds are generally better suited for long-term investment strategies.

    • Goal Alignment: Choose an index fund that aligns with your investment goals, whether that's growth, income, or international exposure.

    • Research: Always research the specific index fund, including its fees, historical performance, and the index it tracks.

 

Real Estate

• Before I even dive into this section, I need to add a disclaimer: Real estate investing is not for everyone. Social media makes it seem very easy when, in contrast, it is extremely difficult. However, if done correctly, it can be a successful strategy.

• At it's simplest terms, there are two forms of real estate investing:

  • You buy a house, you fix that house, and you sell that house for a profit. 

  • You buy a house, you rent out that house to tenants, and you collect income. 

  • Which strategy you decide to do is completely up to you, but be forewarned, each comes with its own degree of risk, complication, and expense.

• Let's start with #1 -> buy, fix, sell.

  • You find a house for $100,000, but it needs some work. You put $50,000 into the house to fix it up, and the updated house increases in value. If you sell the house for $200,000, then you made $50,000 in profit. Right?

  • As you'll see in Calculation #1, there is a bit more that goes into the house then just Sale Price less the Purchase Price.

    • Down Payment -> Every mortgage requires a down payment. Some down payments can be as low as 3.5%, whereas some investment properties require 20-25%. All is dependent on the lender and the type of real estate transaction.

    • Closing Costs -> This is a sneaky expense that first time homebuyers can be unaware of. These are costs needed to close on the home and be anywhere from $8,000 - $20,000 (or more). They include (not always, and not limited to):

      • Origination Fee: Charged by the lender for processing the loan application, typically 0.5% to 1% of the loan amount.

      • Discount Points: Optional fees paid to the lender to reduce the interest rate on the mortgage.

      • Underwriting Fee: Covers the lender's cost of evaluating and approving the loan application.

      • Application Fee: Charged by the lender to process the mortgage application, may include a credit report fee.

      • Prepaid Interest: Interest paid upfront to cover the period between the closing date and the first mortgage payment.

      • Appraisal Fee: Cost of having the property professionally appraised to determine its market value, required by the lender.

      • Home Inspection Fee: Paid to a professional inspector to assess the property's condition, often required or recommended before finalizing the purchase.

      • Survey Fee: Covers the cost of verifying property boundaries, which may be required in some locations.

      • Pest Inspection Fee: Required in some cases to check for termites or other pests, especially in certain regions.

      • Title Search Fee: Covers the cost of searching public records to verify the seller’s legal ownership and check for any liens or claims on the property.

      • Title Insurance: Protects the buyer and lender against any future claims or disputes over the property’s ownership. There are usually two policies: one for the lender (required) and one for the buyer (optional but recommended).

      • Escrow Fees: Paid to the escrow company or attorney who manages the funds and documents during the closing process.

      • Recording Fee: Paid to the local government to officially record the change of ownership and the new mortgage.

      • Transfer Taxes: Taxes imposed by the state, county, or city when the property changes ownership.

      • Property Taxes: Depending on the closing date, buyers may need to pay a portion of the property taxes upfront.

      • Homeowner’s Insurance: Buyers are typically required to pay for the first year’s premium at closing to protect against property damage.

      • Private Mortgage Insurance (PMI): If the down payment is less than 20%, the lender may require PMI to protect against default.

      • Escrow Deposit for Property Taxes and Insurance: Lenders often require an upfront deposit into an escrow account to cover future property taxes and insurance premiums.

      • Prepaid Interest: Interest due on the mortgage from the closing date to the first payment date.

      • Attorney Fees: In some states, it’s customary or required to have an attorney present at closing, and this fee covers their services.

      • Courier/Overnight Fees: If documents need to be sent quickly, there may be a fee for courier or overnight services.

      • Notary Fees: Charged for notarizing documents during the closing process.

      • HOA Fees: If the property is part of a homeowner’s association, there may be upfront payments required for dues or transfer fees.

  • Now comes to the repair costs. Each home is different and will require a different amount to get the house ready to be resold.

    • It is very important to have an understanding of how much these repairs are going to cost before purchasing the home. You don't want to under-budget, spend more than anticipated, and cut into your expected profits.

    • For anyone doing these repairs themselves, power to you. Do your research and make progress every day.

    • For anyone that is going to hire a contractor, DO YOUR RESEARCH. Understanding the work needed to be done is essential to ensure you don't get screwed. Get as many quotes as you possibly can to help reasonably estimate costs (and get the best number).

• #2 -> Buy and hold forever.

  • You find a house for $100,000, the monthly payment (mortgage, insurance, taxes, etc.) is $1,500, you rent it out for $2,000, and you make $500 per month. Right?

  • In theory, yes. But you also have to consider that things will go wrong. Toilets break, roofs leak, and someone has to cut the grass.

  • I love the idea of rental properties and creating a source of passive income. But don't be fooled by the alure of social media - real estate is never truly passive.

  • Don't believe me? Just think about all the places you (or your family/friends) have rented before. Shit went wrong, right? And someone had to fix it.

  • It's a great game to be in, but it is truly a long-term game. Have extra capital in the bank for when things go wrong or a tenant doesn't pay on time. Better be safe than broke.

 

Tips            

 

What if my only goal in life is to invest in real estate?

• I get this all the time - why should I invest in an IRA or permanent life insurance or even have a high-yield savings account if my ultimate (and only) goal is to invest in real estate?

• Great question. These guidelines are the baseline of financial planning, so they are really geared to a broad audience. Specifically, I am talking to those who have no idea what to do.

• If you know in your heart that real estate investing is your true calling, then I say go for it. You can eliminate most of the steps and jump right into saving to buy that first home.

 

However, I caveat this with a couple points:

1. You must, and I repeat must, have an emergency fund and pay-off all high-interest debt. You need to protect yourself in case you lose your job.

2. Whatever number you have in your head that you need to save for your first purchase, add 25-50% to that. Things go wrong and this gets very expensive. Don't go for broke on your first home and have nothing to fall back on.

3. Talk to people in the industry that have had success. They might not give you all the answers, but their answers are definitely better than some shmuck on social media (myself included). Get a mentor and learning everything you can.

4. Last but certainly not least, build a friggen budget. Know what you make, what you spend, and what you keep. It's the only way to properly project savings and efficiently plan for the future. Let me help you if you need a place to start.