Finally have some money - looking for insight

[cheapinsd]

Hey everyone, looking to get some help in figuring out the best strategy for investing as I haven't been doing it for very long and this year is the first year I have made enough money to do more than max out my Roth.

A quick overview on my situation:

- 25 years old, married, kid on the way
- Live in San Diego, own my own home, 20% equity and plan to turn it into a rental in 2-3 years. Will likely cash flow around $400-$500.
- I know many are pro renting, but I work in real estate and prefer investing in it because I see the benefit firsthand and know the industry well. I plan to purchase another home with 10% down (~$600k purchase price) in the next 2-3 years.
- Currently have ~$25k in my Roth IRA's and my wife and I both max out.
- Have ~$8k in 529 plan and contributing $150 per month
- Fully funded emergency fund in high yield savings account
- Wife salaried at $80k and my job is commission based. This year I expect to gross $250k between the two of us.
- We have a zero based budget to have all expenses paid by wife's salary and everything I make is set for investing

I currently have an additional $50k in cash that I'm not sure what to do with. Here are a some questions:

-  Trying to structure my investing in a way that will bring down AGI and allow me to continue maxing Roth (Unless this is a terrible strategy?). Thoughts on SEP, Simple, i401k? Leaning toward the i401k, should I do Roth or use the Traditional to bring down AGI?
- For funding the new account, I want to set up something I can set and forget - any recommendations for low cost index funds through fidelity? I have our Roth accounts balanced and funds chosen, should I just use the same ones or use a single fund?
- For the $60k I will need to buy a home in 2-3 years what should I do? Considering incrementally setting aside money in Savings, but friends have said to invest in single stocks (Apple, Google, etc.) and just pull it out when I need it.
- Any other recommendations or advice is appreciated.

I don't know much about investing, but have been good at budgeting and saving so far and want to continue getting to FIRE. Thanks in advance for any help!

[Another Reader]

You have never been through a real estate downturn.  In your business, you need reserves to carry you through difficult times.  As long as your wife is employed, you have the basics covered.  If she loses her job in a recession and you aren't selling anything, you need liquid reserves to fall back on.  Your emergency fund needs to be more robust than most.

You think your house will cash flow around $400 to $600.  Have you prepared an operating statement showing income and all expenses to check your assumptions?  If you are allowing a little vacancy and subtracting the mortgage payment from the rent, you have not accounted for all expenses.  The 50 percent rule of thumb exists for a reason.  Furthermore, rents don't always go up.  When it comes time to rent this house out, market rent may be higher or lower than current market rent.

If you think you will buy a home or anything else in three years, high yield savings, short term CD's and US treasuries are the way to go.  Treasuries have the added benefit of being state income tax free.  The advantage of being relatively liquid is this cash will be a second layer of protection if the SHTF in the next couple of years.  If the market does go south, and you have sufficient income, you might find a bargain.  If you invest the money in the stock market, and the stock market tanks at the same time real estate values drop, you won't have money to pull out of the market to buy.

Levering up to 90 percent to buy another house while we are at or near the peak of the market might be something you want to reconsider.  If values drop and you are insufficiently capitalized, you will be short selling or giving the property to the bank.  Will you spend down your reserves to support an underwater property?  A lot of people bailed between 2008 and 2012 rather than wait out an uncertain future.

Is your wife maxing out her 401 (k)?  As long as you have high income, she may want to do that. That will cut your current tax liability.

In your shoes, I would talk to people in the business that survived the last downturn successfully.  Some perspective on the cyclical nature of your business and how to succeed in spite of that may be useful to you.

[cheapinsd]

You have never been through a real estate downturn.  In your business, you need reserves to carry you through difficult times.  As long as your wife is employed, you have the basics covered.  If she loses her job in a recession and you aren't selling anything, you need liquid reserves to fall back on.  Your emergency fund needs to be more robust than most.

You think your house will cash flow around $400 to $600.  Have you prepared an operating statement showing income and all expenses to check your assumptions?  If you are allowing a little vacancy and subtracting the mortgage payment from the rent, you have not accounted for all expenses.  The 50 percent rule of thumb exists for a reason.  Furthermore, rents don't always go up.  When it comes time to rent this house out, market rent may be higher or lower than current market rent.

If you think you will buy a home or anything else in three years, high yield savings, short term CD's and US treasuries are the way to go.  Treasuries have the added benefit of being state income tax free.  The advantage of being relatively liquid is this cash will be a second layer of protection if the SHTF in the next couple of years.  If the market does go south, and you have sufficient income, you might find a bargain.  If you invest the money in the stock market, and the stock market tanks at the same time real estate values drop, you won't have money to pull out of the market to buy.

Levering up to 90 percent to buy another house while we are at or near the peak of the market might be something you want to reconsider.  If values drop and you are insufficiently capitalized, you will be short selling or giving the property to the bank.  Will you spend down your reserves to support an underwater property?  A lot of people bailed between 2008 and 2012 rather than wait out an uncertain future.

Is your wife maxing out her 401 (k)?  As long as you have high income, she may want to do that. That will cut your current tax liability.

In your shoes, I would talk to people in the business that survived the last downturn successfully.  Some perspective on the cyclical nature of your business and how to succeed in spite of that may be useful to you.

Thanks for your feedback, I appreciate the input.

As far as the future downturn of the market and building my business to sustain that - definitely a work in progress and something I am accounting for. I hope to continue making money and seeing my income go up, but anticipate a downturn at some point (to whatever degree it happens) and am saving my money for that reason. The purchase of my next home will definitely depend on what happens with the market as well.

I'm just spit balling potential cash flow and rental income, but that will definitely change in the next 2-3 years depending on the market as well.

I think what I am looking for more insight on is less in regards to purchasing/renting the homes and more what to do with my cash now:

I have an emergency fund in a high yield savings of $50k. Would you recommend more?

I am working on how to invest everything over and above that emergency fund (another $50k currently, and all future income).

My wife is not contributing to her 401k and I haven't either. Would you recommend that as the next step along with incrementally setting aside in treasury/high yield savings?

[ILikeDividends]

I think what I am looking for more insight on is less in regards to purchasing/renting the homes and more what to do with my cash now:

You can't really isolate the two from each other.  Also, are you sure you can get a 10% down mortgage on an investment property?  I havn't looked into it in a few decades, but I'd be surprised if you could do that now.

Is 50K enough of a safety net?   Damned if I know.  Can you pay a mortgage, cover repairs on your own home and the rental(s), pay liability insurance on your rental(s), litigate an eviction with no income coming in for a year, all during a multi-year downturn in the RE market, and still support your lifestyle with just your wife's income for 3, 4, or 5 years?  What if she gets laid off at the worst possible time?

No one can tell you if $50K is enough for all of that, but a mere 50K cushion seems to come with some pretty aggressive assumptions to me.  It could be wildly successful.  But what if it isn't?

If you weren't planning on becoming a real estate mogul (and hey, nothing wrong with that, eh?), the answer to where to invest your excess cash flow becomes a lot simpler.

Renting real estate, however, is by no means a passive activity.  If you treat it like a passive investment, you will lose.  Be prepared to bust your ass doing it, if you're going to be successful.

Make sure you are well-versed in Federal and State fair housing laws before you embark on this approach:

https://en.wikipedia.org/wiki/Fair_Housing_Act

Source of income (welfare, food stamps, etc), in California, cannot be used as a reason to deny a rental; otherwise, you open yourself up to a losing lawsuit.  Being a landlord in California pretty much means you are a junior partner with the State and Feds, where you bear all the risk.

There are definitely "renter sharks" swimming around that might know how to exploit the laws much better than you might, if you're not at the top of your game.  You also need to become familiar with any rent-control ordinances, if they exist, in San Diego.

Renting real estate is a very different game than selling it.

[Bicycle_B]

-  Trying to structure my investing in a way that will bring down AGI and allow me to continue maxing Roth (Unless this is a terrible strategy?). Thoughts on SEP, Simple, i401k? Leaning toward the i401k, should I do Roth or use the Traditional to bring down AGI?

The different account types (SEP, Simple, i401k) have different rules that will have consequences based on your income type (source... are you employed W2 on commission, or you're an independent contractor, or getting commission while somehow an LLC; is the SEP or SIMPLE plans that you would participate in that your employer started, or plans that you would start?...) and amount.  Can't advise you which is better without knowing details.  I myself couldn't advise you anyway, but based on your plan to invest in real estate, I suggest researching the options more carefully.  Then evaluate based on the following in descending order of importance:

1) Ability to access funds
2) Ability to choose stable investments
3) Tax impact
4) Cost/hassle

As you research, find out which ones can be easily changed.  Make sure your chosen strategy is flexible enough to meet your primarily goal, real estate investing.