10,000' Case Study — Opinions On Where to Land and When to Pull Chute

[LadLiquidLonghair]

I'm still at the broad-strokes stage of getting my FIRE-ness in order. Been frugal-ish for a long while. I like to start at the goal:

GOAL
$50K annual "passive" (non w-2) income after primary mortgage is paid off

INCOME SO FAR
As mentioned in a RE thread I started, targeting $1500/month ($18,000) annual from an ADU on our primary, roughly rent-able-shape early next year (short-term vs. long-term not yet determined.

https://forum.mrmoneymustache.com/real-estate-and-landlording/1-deals-don't-exist-local-market-saturated-with-rentals-now-what/

GAP
$32,000

Now here's where I'm stuck, scratching my head:

LIQUID, INVESTABLE ASSETS
$600K, currently sitting in a 4.65% APY money market account

DEBT
...also $600K — my primary residence

INCOME
$200K annual w2*
*big caveat, my career has gone on ~5 year arcs where I work up to a high salary, then the company folds or gets bought or the job changes and I have to reinvent myself. I'm currently on the what feels like the back of my second bountiful up, already planning that I may have to jump back in the water to yet again...
**these jobs stress me out and my health is suffering...
***I'm in tech


What would you do if you were me? Your goal is to get me passive ASAP. (Redundant per forum, no?).

I will still keep working but on things that motivate and inspire me. (Double-redundancy?)

I'm in for all the crazy ideas — moving from primary is off-limits.

TY

[lucenzo11]

I think most responses on here are going to have a hard time providing answers to your questions as you've given us some of the high level details, but the case studies on here typically are more detailed. Check out the how to write a case study post for some more details on what we like to look for: https://forum.mrmoneymustache.com/case-studies/how-to-write-a-'case-study'-topic/

But I'll take a whack at looking at your situation based on what you've presented and then comment on what is really needed to provide a better answer.

Your goal is to have $50k a year passive plus mortgage paid off. $50k x 25 (4% rule) + $600k (mortgage) = $1.85M. That's what you would need to meet your goal. You have $600k saved up and your $18k per year is equivalent to $450k invested at 4% so your deficit is $800k. So overall, I see it as you have a ways to go, but you may be in much better position with your high income and large amount of liquid if you can utilize it in the right way.

Some data that would be really good to have and why:
1. Your current spending. $200k is a really nice income so congrats on achieving that, but how quickly you can save up to your goal is also dependent on how much you spend. It will also give us a sense of how sensitive your financials are to losing your job if that were unfortunate enough to happen as you speculated.
2. Terms of your mortgage. Monthly payment, interest rate, time remaining. Seems like you want to pay it off sooner than later, but still would be good to understand if this is a brand new or something that you've been paying off for a while. Also, it may not make sense to pay off your mortgage.
3. Do you have anything in IRA or 401k? Is the $600k truly all investable in anything including real estate without paying taxes for taking it out? Does this include your emergency fund?
4. Is your $18k a year from the ADU gross or what you expect to net. This is not something I'm familiar with doing but you have to consider vacancy between rentals, maintenance, unexpected repairs, etc. I'm assuming you'll maintain it yourself.
5. Approximate age and life plans. This isn't totally necessary to provide, but it's generally good to know especially if you have kids or plan for kids.

If you can provide that data, I think you'll get some much better responses. The more information the better.

[LadLiquidLonghair]

Thanks for responding, Lucenzo.

Mortgage is 30 year fixed at 3.65%, approx 28 years left. $3K monthly payment + $500/month taxes and insurance (not escrowed, paid separately).

I'm in my early 40s. Married, one disabled child who will probably live at home their entire life, I'm the sole income earner.

ADU figures GROSS and yes, does not account for vacancy.

$600K is investible and currently "IS" just sitting there ins the 4.65% APY MM. I have additional $50K emergency and a $150K CD at 5% also parked until next year, planning that $150K for taxes.

I have NO OTHER investments at this time. No 401K, no Roth.

We already live off a $50K annual spend OUTSIDE OF the mortgage and some necessary property improvements, which I'm trying to whittle down.

We are not planning any money from SSDI since my income is so high, that could change in the future but I'm trying to plan for not ever having that. For life plans/future spending, we figure out of $4200 needed monthly (again, outside of mortgage), $1000 would go to healthcare, and $500 would go to property taxes and insurance.

Sorry if this was the wrong forum bucket (case studies), I am hoping for some broad guidance into strategies to create passive income with what I got. Probably doesn't make sense (now) to try and cut up the margins of that $50K annual spending goal... or in any case, I'm thinking more generally about what do I do with this liquidity, do I pay off my mortgage, how fast can I get to some cashflow, and what strategies will help me get to cashflow?

I don't have anyone in my life I can talk to about money, so thanks very much in advance!

#noob

[VanillaGorilla]

Welcome LLLH!

You clearly have the frugality bit down, with $800,000 in short term assets. Are you familiar with the "4% Rule"? Are you looking to fund your life off a portfolio of stocks and bonds in addition to real estate? Or (as your "cash flow" comments might indicate) are you looking to live off direct income streams like rent and dividends?

If you haven't been using a 401k, then you're paying a lot more in taxes than you need to.

Paying off your house is mathematically disadvantageous.

If I were in your shoes my priorities would be

• Optimize taxes via investing in a 401k, IRA, HSA, all the tricks (read the Mad Fientist website for a good primer)
• Start investing in equities (see, e.g. The Simple Path To Wealth)
• Pay off the mortgage only when you're ready to quit your job

You're already in a very strong position and there's a ton of excellent information online and on this forum, you should be able to formulate a strategy easily. You need roughly $1M invested in stocks and bonds along with your ADU income and a paid off house, so $1.6M. Your current assets appropriately invested along with your savings rate should get you to that immediate goal within five years.

[JAYSLOL]

Keep the $50k emergency fund in the high yield as cash, but I would start getting some of that $600k invested, and as much as you can into tax advantaged accounts if I were you, I believe* you and your partner could each open a Roth IRA and deposit $6500 each per year, which should be invested in the market for long term growth.  If your employer offers a 401k, you should be maxing that out every year, if you are doing contract work you might qualify to open a solo 401k, which again you should max out and have invested in the markets.  I wouldn’t pay off a sub-4% mortgage early (unless someone handed me a check for millions, then I’d consider it just to simplify things).  You could pay cash for another rental property if you wish, I would probably bump up your emergency fund to include 6 months worth of whatever the rent and taxes would be worth to cover repairs/issues/vacancies etc (maybe an extra $20k) if you buy a rental so you don’t have to go into debt or take money out of an investment account.  I don’t know what the market is like in your area for real estate though.  Either way, if it were me, I’d want a balanced mix of passive money coming from rentals and index funds, I wouldn’t want my only income to be rental.  Your spending sounds fairly reasonable, so you are able to save what? $75k/year after expenses/taxes/mortgage?  You may wish to spend a few months actually tracking every dollar, doing a detailed breakdown of where the money is going here, then working on a more optimized budget to speed things up. 

*I’m in Canada, so not 100% up to speed on US accounts, so others here can confirm if my understanding is correct. 

[zolotiyeruki]

The Investment order[/i] post is a fantastic starting point.  You can deviate from it as circumstances permit.

Here's what I would suggest:
1) max out a 401k, either through your employer if you can, or solo if you can't
2) both of you should open a Roth IRA and max out your contributions
3) put that $600k to work more efficiently--get it in index funds.  It doesn't get much more passive than that.
4) invest any leftover income in index funds via a taxable brokerage account.

Roughly speaking, an income of $200k, with a standard deduction of $28k, means FICA taxes of $12k and federal income tax of about $28k.  Let's assume another $10k (5%) of state income taxes.  That leaves you $150k to take home.  Your total expenses are $86k, so you have roughly $64k/year available to invest.

After you max out your 401k, your taxes are reduced by $6k, so you have ($64k - $22.5k + $6k) = $47.5k.  $13k into Roth IRAs leaves you with $34.5k to invest in your taxable account, and a total of $70k added to your investments (retirement and otherwise) per year. 

@lucenzo11's analysis of the numbers needed to retire seems pretty reasonable, although a few adjustments are needed to account for the $1200/mo from the ADU being gross instead of net.  If you net $10k/year from the ADU, you need $40k of income from investments.  By the 4% rule, you need $1M saved up.  Add to that the amount you need to either A) pay off the house, or B) cover the cost of your payments until it's paid off.  Option A is simpler to model.  If you assume 7%-after-inflation growth for index funds, and add $70k/year added to your stash, in about seven years, you'll hit the point where you'll have saved enough to pay off the rest of the mortgage and to retire.

[ChpBstrd]

Your $600k could be invested today in SGOV and earn your $32k income gap risk-free. By adding a little risk, you could lock in about a 6% return and make that $36k. The passive income part is easy these days. Click the "buy" icon and mark this goal accomplished.

However, you also want a paid-off mortgage, and this is where the troubles start. First of all, does it make sense to prepay even a dollar on a 3.65% mortgage when risk-free investments are yielding almost 5.5%? I.e. would you take money out of an account earning 5.5% to put it into an account earning 3.65%?

So let's consider two paths:

1) You POYM, end up with no assets other than the house, and get your spending down to $50k/year. Your next task to FIRE (the presumed goal, although you didn't state it) is to save up / invest up a 25x FIRE number of $1.25M starting from zero.

2) You keep the mortgage and try to FIRE on spending of $86k/year. Now you need a 25x FIRE number of $2.15M but you have $600k in seed money to start with. Thus you need to save up / invest up $1.55M.

#1 might superficially seem like the fastest path because you can apply the $36k per year mortgage savings to building the nest egg, and because you have a lower 25x FIRE number. However, you miss out on the compound returns from your $600k in assets which largely negates these benefits. Also, #2 has hidden safety features not reflected in the napkin math: After year 28, a big chunk of your spending goes down, which means that if your portfolio is struggling at this future time, there is relief ahead. Second, if mortgage rates ever go below your 3.65% rate - as unlikely as that may sound today, it could happen - you have the option to refinance. Third, you end up wealthier when you FIRE in scenario 2 than when you FIRE in scenario 1. Finally, #1 is risky because paying off the mortgage now would leave you at risk if a big expense came up or if your career/income did another cyclical downturn. You'd be house-poor for a while and completely exposed to both the risks of your local real estate market and inflation. 

I did some Excel math with the following assumptions and simple annual contributions and compounding:
Scenario 1: 5% returns, $0 starting point, $136k per year contributions, FIRE number = $1.25M
Scenario 2: 5% returns, $600k starting point, $100k per year contributions (because mortgage reduces amount you can save), FIRE number = $2.15M

Scenario #1 exceeds its FIRE number in year 8 and scenario #2 exceeds its FIRE number in year 10. However, by year 10 your scenario #2 self has about a half million dollars in liquid assets more than your scenario #1 self. This is partially offset by the presumed remaining debt on the house of perhaps $450k. I tried manipulating the rate of return - maybe you invest it all in stocks and earn 10% per year? - and at a 10% return both strategies reach FIRE at roughly the same time, in six years.

So Scenario 1 involves taking more risk (being almost broke for a while, putting all your eggs in one housing market) and giving up a great interest rate on debt that is lower than today's risk-free rate of return, but it can be expected to technically get you across the 25x finish line faster. 

What I actually suggest is a hybrid approach that is the best of both options: Invest your $600k until you reach what would be your FIRE number if your mortgage was paid off plus your mortgage balance, then pay off your mortgage and retire.

[Bartlebooth]

With $600k in shovel-ready investment cash, dreams of "getting passive ASAP", $150k set aside to pay taxes, no retirement accounts, and no information provided about your spending, I'll speculate:

• Have you just had an $800k windfall from startup IPO or crypto or something, leaving $600k after taxes and emergency fund?
• Have you had poor (aka "normal") fiscal responsibility in the past (no retirement accounts!) and want to use this opportunity to turn things around?
• Did you pull the $50k spending number out of thin air as a goal and current spending is far higher?  (Where else would $200k per year go assuming the windfall situation and then not having any other savings?)

[li]
[/li][/list]

FI is not an ASAP mission.  It is a steady building of positive habits that yield rewards over time.  Spending, saving, and income are the categories of the habits.  All three of those for you are currently highly irregular, from what I can tell.

Your real growth will be in the development of these habits for the rest of your life (if you choose).

BTW: Investment real estate is a distraction unless you have specific circumstances giving you an advantage.  And should be eased into, not $600k dropped into it.

[LadLiquidLonghair]

...I'll speculate:

• Have you just had an $800k windfall from startup IPO or crypto or something, leaving $600k after taxes and emergency fund?
• Have you had poor (aka "normal") fiscal responsibility in the past (no retirement accounts!) and want to use this opportunity to turn things around?
• Did you pull the $50k spending number out of thin air as a goal and current spending is far higher?  (Where else would $200k per year go assuming the windfall situation and then not having any other savings?)

[li]
[/li][/list]

FI is not an ASAP mission.  It is a steady building of positive habits that yield rewards over time.  Spending, saving, and income are the categories of the habits.  All three of those for you are currently highly irregular, from what I can tell.

Your real growth will be in the development of these habits for the rest of your life (if you choose).

BTW: Investment real estate is a distraction unless you have specific circumstances giving you an advantage.  And should be eased into, not $600k dropped into it.

Entrepreneurship? I think you're describing entrepreneurship. I'm a bad corporate worker but a C+ entrepreneur. Some up years, some down years, some windfalls. I feel seen.

Oh, except for the spending part. Household expenses on lock. Failed business ventures, sure? But old cars old clothes grow my own food don't drink don't smoke don't travel, even got rid of my smartphone for a bunch of years.

See also: about $100K in medical bills over the last 15 years. Including years I made $0 trying to get something off the ground.

As I said, I'm at another transition period, and want to use this opportunity to take a leap ahead.

[LadLiquidLonghair]

Welcome LLLH!

You clearly have the frugality bit down, with $800,000 in short term assets. Are you familiar with the "4% Rule"? Are you looking to fund your life off a portfolio of stocks and bonds in addition to real estate? Or (as your "cash flow" comments might indicate) are you looking to live off direct income streams like rent and dividends?

If you haven't been using a 401k, then you're paying a lot more in taxes than you need to.

Paying off your house is mathematically disadvantageous.

If I were in your shoes my priorities would be

• Optimize taxes via investing in a 401k, IRA, HSA, all the tricks (read the Mad Fientist website for a good primer)
• Start investing in equities (see, e.g. The Simple Path To Wealth)
• Pay off the mortgage only when you're ready to quit your job

You're already in a very strong position and there's a ton of excellent information online and on this forum, you should be able to formulate a strategy easily. You need roughly $1M invested in stocks and bonds along with your ADU income and a paid off house, so $1.6M. Your current assets appropriately invested along with your savings rate should get you to that immediate goal within five years.

Thank you @VanillaGorilla . Appreciate the practical advice. Lots to read up on RE: the investing part. Had definitely focused on grinding to a liquidity event and keeping expenses low, kinda happened abruptly and here I am going "now what?" Head has been down for a long time.

To answer your first question, I'm familiar with the 4% annual draw down rule, but no I kinda thought I wasn't going to be able to buy enough stock to ever do that, plus I hate gambling and am super stock market risk averse (no need to address that here, I know it's a me thing). I could get down with a five year plan, that's the potential 10K' view I was after, not even sure what picture to paint.

Appreciate you.

[LadLiquidLonghair]

Your $600k could be invested today in SGOV and earn your $32k income gap risk-free. By adding a little risk, you could lock in about a 6% return and make that $36k. The passive income part is easy these days. Click the "buy" icon and mark this goal accomplished.

Mhhmm, mhhhmmm.

However, you also want a paid-off mortgage, and this is where the troubles start. First of all, does it make sense to prepay even a dollar on a 3.65% mortgage when risk-free investments are yielding almost 5.5%? I.e. would you take money out of an account earning 5.5% to put it into an account earning 3.65%?

So let's consider two paths:

1) You POYM, end up with no assets other than the house, and get your spending down to $50k/year. Your next task to FIRE (the presumed goal, although you didn't state it) is to save up / invest up a 25x FIRE number of $1.25M starting from zero.

Yeah, that doesn't sound great going from 0 to $1.25M.

2) You keep the mortgage and try to FIRE on spending of $86k/year. Now you need a 25x FIRE number of $2.15M but you have $600k in seed money to start with. Thus you need to save up / invest up $1.55M.

Yup, you get me.

#1 might superficially seem like the fastest path because you can apply the $36k per year mortgage savings to building the nest egg, and because you have a lower 25x FIRE number. However, you miss out on the compound returns from your $600k in assets which largely negates these benefits. Also, #2 has hidden safety features not reflected in the napkin math: After year 28, a big chunk of your spending goes down, which means that if your portfolio is struggling at this future time, there is relief ahead. Second, if mortgage rates ever go below your 3.65% rate - as unlikely as that may sound today, it could happen - you have the option to refinance. Third, you end up wealthier when you FIRE in scenario 2 than when you FIRE in scenario 1. Finally, #1 is risky because paying off the mortgage now would leave you at risk if a big expense came up or if your career/income did another cyclical downturn. You'd be house-poor for a while and completely exposed to both the risks of your local real estate market and inflation. 

Good explanation, thank you.

I did some Excel math with the following assumptions and simple annual contributions and compounding:
Scenario 1: 5% returns, $0 starting point, $136k per year contributions, FIRE number = $1.25M
Scenario 2: 5% returns, $600k starting point, $100k per year contributions (because mortgage reduces amount you can save), FIRE number = $2.15M

Scenario #1 exceeds its FIRE number in year 8 and scenario #2 exceeds its FIRE number in year 10. However, by year 10 your scenario #2 self has about a half million dollars in liquid assets more than your scenario #1 self. This is partially offset by the presumed remaining debt on the house of perhaps $450k. I tried manipulating the rate of return - maybe you invest it all in stocks and earn 10% per year? - and at a 10% return both strategies reach FIRE at roughly the same time, in six years.

So Scenario 1 involves taking more risk (being almost broke for a while, putting all your eggs in one housing market) and giving up a great interest rate on debt that is lower than today's risk-free rate of return, but it can be expected to technically get you across the 25x finish line faster. 

@ChpBstrd I really appreciate you taking the time to run some numbers here for an internet stranger. I've read this 10 times to digest.

What I actually suggest is a hybrid approach that is the best of both options: Invest your $600k until you reach what would be your FIRE number if your mortgage was paid off plus your mortgage balance, then pay off your mortgage and retire.

So once I have $50K in annual income coming from NEST EGG X (roughly $1M) and an additional (let's say future principle balance of) $500K, then FIRE. So instead of $1.25M (scenario 1) or $1.55M (scenario 2), the goal here is actually a $900K gap.

So then my question/plan is:
- how quickly (and safe-ishly) can I 2.5X $600K into $1.5M

I failed calculous, but here is some arithmetic I can get my head around. Owe you one.

[LadLiquidLonghair]

  Your spending sounds fairly reasonable, so you are able to save what? $75k/year after expenses/taxes/mortgage?  You may wish to spend a few months actually tracking every dollar, doing a detailed breakdown of where the money is going here, then working on a more optimized budget to speed things up. 

Thanks @JAYSLOL , appreciate you laying out diversified portfolio options in layman's terms.

And yes, easily saving $7K a month right now.

[LadLiquidLonghair]

The Investment order[/i] post is a fantastic starting point.  You can deviate from it as circumstances permit.

Here's what I would suggest:
1) max out a 401k, either through your employer if you can, or solo if you can't
2) both of you should open a Roth IRA and max out your contributions
3) put that $600k to work more efficiently--get it in index funds.  It doesn't get much more passive than that.
4) invest any leftover income in index funds via a taxable brokerage account.

Roughly speaking, an income of $200k, with a standard deduction of $28k, means FICA taxes of $12k and federal income tax of about $28k.  Let's assume another $10k (5%) of state income taxes.  That leaves you $150k to take home.  Your total expenses are $86k, so you have roughly $64k/year available to invest.

After you max out your 401k, your taxes are reduced by $6k, so you have ($64k - $22.5k + $6k) = $47.5k.  $13k into Roth IRAs leaves you with $34.5k to invest in your taxable account, and a total of $70k added to your investments (retirement and otherwise) per year. 

@lucenzo11's analysis of the numbers needed to retire seems pretty reasonable, although a few adjustments are needed to account for the $1200/mo from the ADU being gross instead of net.  If you net $10k/year from the ADU, you need $40k of income from investments.  By the 4% rule, you need $1M saved up.  Add to that the amount you need to either A) pay off the house, or B) cover the cost of your payments until it's paid off.  Option A is simpler to model.  If you assume 7%-after-inflation growth for index funds, and add $70k/year added to your stash, in about seven years, you'll hit the point where you'll have saved enough to pay off the rest of the mortgage and to retire.

Thank you for the simple-to-understand breakdown.