Case Study: 23 y/o Asset Allocation (High NW but way out of balance!)

[WanttoFIRE]

Hi all! First post on the site, great to be here! Have a good problem to have, but hoping that you all can help! My wife and I have a goal to retire by 30 with 1.5MM plus a paid off house (approx 500-600k in the area we want to be in).We are off to a great start thanks to a small side business we started and some rental real estate investing. We clearly like side businesses more than our W-2 jobs!. Time is our biggest friend right now and we are trying our best to capitalize on the opportunity.

Howver, the problem is that I feel like we will be dangerously overweight in RE holdings if we want to FIRE  and all of our financial investments will be stuck in a 401k until 60.

Current situation
Net Worth: 720k
Primary Residence Equity: 250k (needed a big  down payment to get the place thanks to our age)
Rental Real Estate Equity: 370k (10 rental properties-most are leveraged)
401k: 75k (we both max)
Roth IRA: 10k
Cash: 10k

So clearly we are ridiculously overweight real estate- and I feel like relying on rental income from 30-60 is very risky. If we both max out our 401k until 30, my math is calculating around 1.75-2MM at 60 if we just let it sit.

My questions:

What can we do from now until 30 to make years 30-60 more diversified? Should we be shifting allocations specifically to retire early? My thoughts were:

1) Max out Roth as we can always withdraw contributions. We should stay under the limit for a while thanks to the 36k 401k deductions
2) Stop investing in real estate (even though we love it and we currently don't have enough rental income to cover expenses)
3) After 11k limit for Roth contribute to taxable account

Any other ideas would be appreciated!! I think the simple answer is going to be just build a taxable account balance, but just trying to think everything through. The taxable balance by 30 won't be that significant though

Thanks!

[former player]

Welcome, and congratulations on where you've got to already.

With high incomes the tax advantages of putting money into the 401k look difficult to pass up.  I would suggest funding them to the point at which they will then grow to fully fund your expenses from age 60 (or whenever they will first become available to you - might be 55?).  That gives you an incredible level of security, flexibility and choice over the 30 years between 30 and 60.   Your maxing the 401ks until 30 gives you a projected income at 60 of $70k.  How does that fit with your expected expense?  You say nothing about your current expense levels, which would be a reasonable guide to future expected expenses.

I agree the Roths seem to make sense for you.

Why do you think relying on rental income from 30 to 60 is very risky?   With 10 properties you have already spread the risk much more than if you only had one.  As long as your properties were bought well, are well maintained and are in an area where demand is likely to remain steady I'm not sure where your risks are over any other form of investing?  Buy and hold for real estate has usually been a winning strategy, as long as the economy the real estate is situated in continues to thrive and you have sufficient levels of equity in them to offset future economic shocks.  (Even if an economy ceases to thrive, as long as people are living in the properties you will get some sort of income from them which makes you better off than otherwise- one set of my grandparents rode out the Great Depression on a small amount of rental income.)

The other thing in favour of real estate for you is that you enjoy it - don't underestimate the value that enjoyment brings to you, nor the fact that enjoying something usually means you pay more attention to it and so are more likely to be successful at it.

The other thing I would suggest you think about is what RE looks like to the two of you.  You like your side businesses and real estate better than your main jobs.  That suggests to me that rather than going into complete RE and earning nothing between 30 and 60 you could transition out of your W2 jobs and into self-employment and managing real estate - think of your side business as a further level of diversification.

[WanttoFIRE]

Thank you very much for the response! I'm projecting that we'll need 60-70k (very conservatively-we don't spend much at all but hard to plan for kids, etc.) If we don't include mortgage payments I don't even think we spend 25k.

This gives me some real encouragement to keep going forward with real estate. I guess my fear is that another 2008 happens (unlikely) and we get a bunch of vacancy all of a sudden, leaving most of our other assets inaccessible. However, like you said I think a transition into self employment might be better for us, even if we can make 10-15k a year as a buffer we should be fine. The side business that got us our initial capital  is now starting to die, but there's nothing quite like being your own boss. It ruined my ability to be a good employee.

[Lepetitange3]

I only have one rental, but when the bubble burst and housing prices plummeted, that rental had more potential tenants swarming it than any other time in the decade I've owned it. 

Will your equity vanish overnight? Sure...

But the tenants will keep rolling in.  If you're looking to keep the rentals long term and not worried about selling, you should do fine.

[Catbert]

You can get to 401k and IRAs prior to 59.5:

https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

Do you enjoy landlording?  Will interfere with your plans after ER?  Those answers can help determine whether or not to put more money into real estate?  I'm concerned that you aren't breaking even after owning 10 properties.  As Lepetitange3 noted owning real estate even in a downturn isn't a catastrophe if you don't have to sell.  But if they are costing you money and you lose your job or have ballon payments, now that's a disaster. 

If I were you I'd max out 401ks and IRAs.  Then I'd concentrate on ensuring a large e-fund for the inevitable emergencies on the rental as well as paying down the rentals enough that they were positive cash flow.

[Kl285528]

You can also manage real estate for others, and get into brokerage to leverage your current real estate business and holdings. Property management creates more annuity type income with low start up capital costs. Just a thought if you're really into real estate.

[cchrissyy]

I don't think it's necessarily "out of balance" to have most of your net worth in real estate, but I do think it's smart if you make sure it's diverse. Are the 10 rentals in multiple cities or states? are they various types of properties?   On one hand it's good to find one thing and do it well, but on the other hand, you can diversify by making sure your property isn't all in the same local market. this protects you against the chance that rents or resale values fall on all your rentals at once. 

[WanttoFIRE]

  Wow, all great posts. Thanks for all of the responses. They are solid Middle/lower income properties but all in the same location. Although I know the market well now, I'll look to expand into another market. My definition of early retirement would be to quit working a desk job to "manage " them- I put that word in quotes because I have a property manager and have no plans of managing tenants on my own. They all have positive cash flow, so I'll look into some more 401k/ IRA early withdrawal rules and building a large emergency fund.

[bocopro]

Hello!

I'd like to write in with the opposite (but strikingly similar) situation: 25Y/O, $800k net worth (w/husband) - want to retire @ about 30 with the same general amt. of money.

We own ZERO rental property, have a mortgage for ourselves (for a couple more years in a high COL area - Boulder) - and ALL of our investments are in stocks, max out our 401ks, etc. - sounds like similar to you guys:

Here's my take:
- all stock gives us a lot of fluctuation, and terrifies me anytime I think of selling that stuff to pay for life expenses.
- It does have the opportunity to "go up" with the market - we buy index funds, ETFs, the boring stuff.
- I still can't, even with dividends, think of our stock as "grocery money" - which you definitely can with ten rental properties.

If I were you, I'd start dumping some extra cash into Betterment every month - we've used 3 brokerage services and we like the ease and return of that one. Also, as a fellow high-income earner, you might benefit a lot from the tax loss harvesting feature. Some diversification into stock might be good for you guys - might be fun, even, to watch some live investments grow in a way that you can't really with houses.

Lastly, WOW. You are killing it. Way to go. Also, young marrieds, go us! Very impressed and what motivation to buy some real estate - getting on that asap! :)

[ChpBstrd]

You have not mentioned the ROE for your real estate portfolio. If it was low, I'd consider selling your lowest-performing units and putting the proceeds into ETFs. In my market, I've never done the math with realistic assumptions and had it come out above 6%. Nope to that. I have REITs yielding higher. But your market may be more profitable.

Unless we're talking about a one-industry small town, diversification would be less of a concern for me than liability. This is mitigated by insurance, of course.

Definitely max your 401ks if you can live off the RE income. The tax savings make this shuffle very worthwhile.