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So here's my situation. I'm 33 and my wife is 38. My salary has increased drastically in the last 1 year to around $200k. Abount a year ago my wife quit her job to take care of our daughter. She may or may not return to conventional employment in a couple of years. My first question concerns recommendations on what to do with her old retirement accounts:

IRA rollover with American Century ,$4k
401(b) and 403(a), $60k
TIAA-CREF account (pretax/ tax-deferred, but not sure what type), $8500

My CFA really likes TIAA-CREF and wants to keep that account there. We are looking into switching the other two account to a different brokerage. CFA favors Schwab and I like what I've heard about Vanguard.
We also need to change allocation and go exclusively with low cost index funds. I am not familiar with the mechanics of such transfers, and I don't want to make any mistakes and have to pay fees or penalties. Any toughts on this?

My employer has set up a defined benefits program and I have the option of contributing to a 401k, but they do not match contributuions. Instead, the contribute $25k/yr into this retirement plan under ERISA regardless of any contribution I make. I have chosen to NOT contribute into the 401k. Last year, I did set up a solo 401k account with Schwab ($4000)under a separate self-employment business My projections show that these funds should probably pay for retirement at 65. I made this decision because I would like to have the freedon to stop working earlier, and I don't want to pay early-withdrawal penalties on those accounts, so I don't want to overfund them.

In less than a year I will become partner of our group, and profit sharing may bring an aditional $200k/yr distributed monthly. Currently my net worth is negative, and debt repayment will be part of the strategy, but I plan to use the bonus money to mostly buy/sell/rent real estate. Is this Foolish or foolish of me? Since plan 1 is the "safe" retire at 65 with the above funds in 100% low cost index funds, I would like to be more aggressive with plan 2 which deals with what to do with the "bonus" money.

As alway all comments and suggestion are appreciated.

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Hi, Cesar,

Congratulations on the large raise and the potential future partner status!

The first thing that struck me in your post is this phrase:
Currently my net worth is negative, and debt repayment will be part of the strategy...

On a $200,000 per year income, absent uninsured medical emergencies, having a negative net worth is a likely sign that you've bit off more than you can chew, somewhere along the line. Where were these debts incurred, and for what purpose? Are they medical debts? Credit card debts? Student loan debts? Are you upside down on your mortgage or your car(s)? Are you living above your means, as substantial as they may be?

My personal philosophy on money management is as follows:
1) Take care of the necessities of today.
2) Clean up whatever happened yesterday.
3) Prepare for tomorrow.
4+) Quality of life improvements.

With a negative net worth, with the possible exception of qualified retirement account funding, I would not even consider investing. And the only reason I say 'with the possible exception of qualified retirement account funding' is because retirement accounts have legal time and dollar limits around their funding, so if you don't contribute by the appropriate deadlines, you lose the tax advantaged growth potential on that money.

Your overall financial plan has got to focus on living within your means first and foremost. No matter how much money you take in today, that money can be spent, and without the necessary spending control discipline, you can overspend even a $200,000 salary plus profit sharing.

You also mentioned this:
My projections show that these funds should probably pay for retirement at 65. I made this decision because I would like to have the freedon to stop working earlier, and I don't want to pay early-withdrawal penalties on those accounts, so I don't want to overfund them.

As for your retirement accounts, there are some withdrawl rules you should know about, if you're looking to fund your retirement with them. Legally speaking, you can withdraw money out of 401(k) accounts, without penalty, around age 59.5 . So you don't need to wait until age 65 to retire, if the account balances are enough to allow you to leave earlier. Additionally, there is a provision in 401(k)s for something called "Substantially Equal Periodic Payments" (SEPP), that allow you to work out a withdrawl plan that let you take money out of those accounts without penalty even earlier, as long as you follow the formula guidelines and distribute the withdrawls ove the appropriate time frame.

On another retirement account front, what are the provisions on your employer's retirement plan? You may be able to draw on that as early as around age 55 without penalty.

The fact is, there are LOTS of ways to access retirement money, penalty free, well before age 65...

In your shoes, I would:

1) Take a snapshot assessment of current financial state.
a) Personal Balance Sheet (assets & debts)
b) Personal Cash Flow Statement (income and outgo)
2) Build a core budget
a) Core living expenses
b) Debt repayment
c) Qualified Retirement investing
3) Determine longer term financial goals
a) Early retirement
b) College education
c) Different house
d) Different car
e) Significant charitible donations
f) etc...
4) Determine lifestyle enhancement desires
a) Cable TV
b) High Speed Internet
c) Meals out
d) Vacations
e) etc...
5) Prioritize financial goals and lifestyle enhancement desires
6) Build a funding plan for the priority items
7) Execute against the plan

Given your income and apparent future career growth, you have a great potential to be financially sound. Just make sure you start off on the right foot, and you should be able to meet many of your highest priority goals.

Best of luck,

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Points well taken Chuck, thanks.

Actually most of the loans ($150k)are educational, and they are low interest. I can understand how being in my 30's, with a good salary, and still having negative worth can send red flags. However, I've been in school all these years, and I've only been out in the work force for a year. paying back debt is a priority, but so is asset building.

I have a budget and live within my means. I also consult with a fee-only CFA(she's on maternity leave). We agree on plan one, but I am still very intrigued by the idea of concentrating my asset building plan on real estate. Any thoughts on this?
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I am still very intrigued by the idea of concentrating my asset building plan on real estate. Any thoughts on this?

Having investigated a few landlord deals with some friends of mine, I'll tell you that my personal research indicates that it normally takes a lot of money, a lot of time and effort, and/or a fair mix of all of the above to be successful in real estate. Personally, I include some REITs (Real Estate Investment Trusts) as part of my overall and diversified portfolio, but I passed on the direct apartment ownership.

Here's what I've found in my experience. Bank financing is more difficult for (new) landlords than it is for owner occupied buildings. At least around here, many banks won't touch you if you can't come up with a 30% down payment, and they won't talk to anyone just starting out who is looking at anything above a 4 unit dwelling.

Of course, the bigger buildings have much better return projections than single family residences or duplexes, but they are a lot tougher for the 'little guy' to get without getting creative with the financing.

When my friends finally found a building that met their needs and projected out well, the only way they could finance it was via the seller, who charged them a pretty hefty rate. Did I mention that the building is in a not so nice part of town, and the reason the seller was selling is because it had been trashed by previous tennants and the ravages of time? As a result, the previous owner was having trouble renting out units in it...

Yeah, given the number of units in the building and neighborhood rents, if it reaches around 70% occupancy and maintenance remains reasonable, the building will throw off a nice return. To get it to that point will require further cash investment and elbow grease, all the while the guys will still be paying the note, insurance, utilities, tax, and other miscellaneous, essentially fixed expenses associated with their business and the property itself. Oh, and that 70% number? That presumes that the tennants pay their rent on time and that my friends manage the property themselves.... Add in delinquent or non paying tennants (remember, this isn't exactly the best part of town) and their associated eviction costs, and/or the additional costs of professional apartment management, and the cash flows start to sour, quickly. Granted, if the guys get the place fixed up and if their repairs hold and if they get it rented out 100% and if the tennants all act nice, pay their rents on time, and treat the place with respect, the guys look to do quite well.

If you have the time, willingness, and ability to do the work yourself, or if you have access to enough capital to buy a large enough property where it can make sense to hire professional management, then direct real estate can make sense. Please don't let me sour you on the concept - people can make some very good money in direct real estate investing, but my personal research leads me to believe it's not as easy as those late night infomercials may imply.

Personally, my ambition and skills do not lead me to be a property manager, and my capital base is limited enough that I can't afford a complex large enough to justify professional management. So while I like the idea of Real Estate, I choose to do my Real Estate Investing via Real Estate Investment Trusts (REITs).

My friends may very well be successful landlords. They may make a killing at it. If it does work for them, it will take them a lot more time and effort that I was willing to give. I, on the other hand, know that in the (slightly less than) five months since I bought my first REIT, I've seen about 4% of my total invested capital come back to me in the form of dividends and return of capital distributions from my REITs (including ex-dividend payments not yet distributed), and in spite of a recent 12% (or so) one day haircut in one REIT I hold, overall, the portion of my portfolio allocated to REITs has held its own.

And that's another thing... Even staying in 'real estate', I can diversify via REITs a lot easier than I can in direct ownership. Yes, I took a huge one day hit in that one REIT, but that one hit didn't rub out my holdings or really hurt any of my other REITs. Additionally, I fully expect that REIT to recover over time. Contrast that with this news story from around here:

In a nutshell, the City of Norwood decided to sieze (via Eminent Domain) nine properties at 'court ordered prices' to make room for new 'upscale' development. Imagine having just purchased your first piece of investment property there, only to be told by some judge that you have to sell your land to the city. Oh, and because the land has to go to the city, it's worth much less than it would have been otherwise, since there are no alternative buyers for the property. Bet you wouldn't be happy.

The few thousand dollars I've put into REITs own a fraction of several buildings and/or mortgages (on the financing side) in geographically diverse locations around the country. Plus, the REITs come equipped with professional management and a corporate structure that requires that at least 90% of their taxable income to be paid out as dividends.

Knowing what I know about myself and my exposure to the dynamics of the local real estate market, direct real estate ownership is not for me, aside from my house. I don't know your temperment, your skills, your local real estate market, or the financing norms in your part of the country.

I will tell you this, though... The last apartment I lived in needed a new air conditioner (after several repair attempts failed), a new roof (after it kept leaking, in spite of multiple repair attempts), and it got a new paint job and carpeting when I moved out. A combination of the aforementioned air conditioner - which leaked when its condensation pipes and/or pan sprung a hole, and the leaky roof caused a flood that damaged the carpet beyond use (mold and mildew) and caused water stains on the walls). There is no way that my apartment complex made any money on my unit while I lived there; the combination of the property taxes plus the cost of needed repairs/replacements easily exceeded the money I spent on rent over the year I lived there.

I believe that across the whole enterprise, the apartment owners made money, but I also think they had in the neighborhood of 200 units in that complex and a total of 40+ different complexes in the metropolitan region.

My anecdotes and personal experiences are just that. Anecdotes and personal experiences. Your mileage may vary, and you may find out that you're a brilliant property picker and manager, in a region of the country where all the timing works in your favor. And I'm sure that the infomercials do produce some successes, but if the "Quick and Easy" methods were so successful, why would the folks spend their time marketing and selling their methods, rather than using the methods to make even more money?

Additionally, in finance, there is a concept called "arbitrage". Arbitrage is a risk free profit that arises from temporary market inefficiencies. Abitrage is very real but it is also very fleeting. An example of arbitrage is this: Say gold is trading at $400 per ounce on one exchange, and at $399.95 per ounce on another exchange. An arbitrage trade exists because an investor can buy gold at $399.95 on one exchange and simultaneously sell it for $400 on the other, pocketing the $0.05 per ounce without taking on any personal risk.

The opportunity lasts only until the excess demand at the lower price market causes prices there to rise, and/or the excess supply at the higher price market causes prices there to fall. In effect, by taking advantage of the arbitrage opportunity, the trader's own actions are causing the opportunity to vanish by impacting supply and demand on each market.

What does this have to do with real estate? Well, from what I've seen, similar market rules apply. If it were really quick and easy to 'flip' properties for a profit at no risk, the competition for those flippable properties would soon drive up their prices to the point where flipping would not be a sure bet. And if it were really quick and easy to buy rental properties with bank financing and no money down, the price of those rental properties would soon rise to the point where the profits would diminish dramatically.

Yes, bargains can be found in real estate. My house was a tremendous bargain. The house across the street from mine just sold, less than a month ago, for 23% more than I bought my house for, just over four months ago. And that house has fewer square feet and a smaller plot of land than I do, although it is a year or so younger and I think that it has an upgraded kitchen. My fiancee and I looked at many, many homes, spending hundreds of hours over several months, before this one came on the market. And if we hadn't done our homework previously, we wouldn't have been able to quickly pick up on the value in this property. So while this house may have been a financial deal, the deal did not come without significant effort.

Aiding us in the effort were a few critical mistakes that the listing agent made in the advertisement. First of all, the listing agent advertised the house as being in an incorporated city with a local income tax and higher property taxes. The house is, in fact, in a township with slightly lower property taxes and no local income taxes, a fact we verified with the county auditor before we got started. Additionally, the advertisement undersold the square footage of the house by about 10%. To compound the error, the advertisement underlisted the number of rooms in the house!

It was a corporate relocation house, and I think the relocation company never saw the house, never did any independent research on the house, but priced it based on the information provided to it by the real estate agent. If that was the same information that we saw in the ad, it was WAY wrong. I do know that at the closing, the relocation company's representative was about as useful as a pet rock when I uncovered several errors in her paperwork. So it wouldn't surprise me to find that the relocation company relied on less than perfect information in pricing the property...

We went on a walk through just after the property got listed, and it was immediately obvious (compared to the other properties in the area and price range that we were looking at), that this house was priced to move. Although I submitted my bid very quickly after the house went on the market, I found myself in a bidding war, because the house was priced to move. Oh by the way, I understand from neighborhood gossip that I was outbid for the house, but because I had a large unencumbered CASH downpayment and the remaining financing already lined up, the seller went with me, instead of the less qualified alternative. Once again, having ready cash helped a lot.

Yet another anecdote and personal story. I'm sorry. All I'm really trying to say is that everything I've seen in real estate indicates to me that there is money to be made, for people willing to do the hands on management and maintenance work themselves or for people with enough capital to purchase enough real estate to make it worthwhile to hire someone to do the management work for them. For my own personal investment in Real Estate though, I'll take advantage of the low cost of entry, easy diversification, professional management, and essentially passive nature of REIT investing.

Are REITs 'the best' way to invest in real estate? Well, for me they are. For you, that's a question you'll have to answer for yourself, based on the factors I've touched on above and any other factors that you may uncover in your own research.

Should you invest only in Real Estate? I can't answer that question for you. I can tell you that I personally would not put all of my money into Real Estate, simply because I am a very firm believer in the power of diversification (but I'm no fan of indexing. That's a topic for another night of insomnia, however).

Best of luck to you,
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I max out on my 401K ($12,000 this year) and both mine and my wife's Roth IRAs ($3,000 each this year). I intend to continue to contribute the max to these accounts every year, but I feel that is all the money I care to invest in the stock market. We invest in real estate with our other funds. My wife is a real estate agent which really helps. We've done well with this approach, just be sure to know your market.

Good Luck,

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Terrific reply and great advice. Are you a "pro"?

I, too, was stunned by the "negative net worth", at that income level. However, as you say, a LOT of people earn terrific money but still somehow spend more than they earn, amazing as that seems to me.

Again, great advice and reply. He (and any others in similar situations) should listen to you.

Thanks for posting here.

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As always all comments and suggestion are appreciated.

Here are some investment suggestions;

1) Invest time with your daughter, by the time she is about 10 or so she will be living in her own world where you are just a visitor.

2) Invest time with your wife, she is a long-term investment isn't she?

3) Invest time in yourself.

4) Live below your means! There will be unexpected turns in your life and financial independence can help you get some types of problems. Live and invest so you can retire early if you want to.

5) Even though most of your debt is student loans you still have negative net worth! While you have good prospects you still have a net worth less than my teenage son's. Take a look at your take home pay and your expenses and figure out how many months of after tax take home pay it will take you to get to a positive net worth. Then ask yourself just how much you saved last month, if these match thats great, if not then figure out why. Sorry to rant but most of your money is still in the future and until you get to a positive net worth and an emergency fund of at least six month take home pay you should be very careful with your money.

6) There are a lot of sharp professional real estate investors out there that have more experience, contacts, and financing than you do. Several professional real estate investors will probably have already declined any direct investment that you hear about. A lot of financial planners also liked the dot.coms at the peak. Until you get a positive net worth you might consider stock purchases of a REIT in one of your tax deferred accounts if you want some real estate coverage.

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