Wealth, Financial Management, and Indexing

I’m currently reading the book Wealth by Stuart Lucas and am really enjoying it.

As I approach chapter 6, I want to take the time to reflect on some of the earlier chapters and the topics covered in them because I think they are very relevant to my interests and also the interests of my family.

Lucas is an heir to the Carnation Company fortune. What I first liked about his outlook on finances was that it was one of preserving and growing wealth across generations instead of squandering it all in this generation. It’s certainly a strong counter example to those who are faced with liquidity events that go off and live the high life; ruining it for everyone else.

This book isn’t like normal personal finance books. It hasn’t once spelled out, over the last 5 chapters, how to do any of the typical personal finance things that you see repeated over and over ad nauseam. Things like

  • Bring your lunch to work
  • Drive less
  • Buy a used car instead of new car
  • Cancel your cable subscription
  • Find hobbies that don’t require spending
  • Stop going to Starbucks in the morning for coffee

Recommendations like this are so common among personal finance bloggers these days that they’re boring to read anymore. Why’s that? Perhaps because none of these financial bloggers are members of the ultra-rich. Nor do they have the academic background in finance like some of these crazy successful wealth managers have.

Lucas speaks about money in a completely different way in his book.

One chapter that I enjoyed was chapter 4 where Lucas talks about defining your financial objectives.

In this chapter he presents two different objectives

  • The “Distribution-Driven” category of Financial Management
  • The “Growth-Driven” category of Financial Management

These two categories are vastly different and the difference between the two is a matter of time horizon, financial acumen, and cooperation. The average person is likely to fit in best with the Distribution-Driven category.

In Distribution-Driven management, your time horizon is short-term; on the order of perhaps 20 years or so. However, definitely not much more than your lifetime. In fact, one of the goals is to have your last dollar spent to cover your burial.

In Growth-Driven management, your time horizon is multi-generational. You strive to grow, and continue to grow, your family’s wealth beyond your and your next of kin’s lifetimes. This takes concerted effort and cooperation amongst you and your family. Resources are pooled. Financial stewards are elected based off their knowledge of finances. In general, I think Growth-Driven management (at the degree I’m reading it) is beyond the ability of most people.

I can certainly see that most people might be able to leave something to their children, but not on the order of what Lucas seems to be describing in Growth-Driven management.

I personally fall squarely in the center of the Distribution-Driven form of financial management. I might leave a bit of scratch to my brothers and sisters, but I have no grand aspiration of building an empire of wealth in my family.

Lucas also re-iterates what he and others have observed time and again when it comes to building that actual wealth for the lay person; indexing wins. Unless you have some significant capital or visionary understanding of financial markets, it’s in your best interest to invest in indexing products; what he refers to as The Capital Kibbutz.

Within the financial industry, he has observed what he calls three “Different Worlds”; the Capital Kibbutz, the Secret Society, and the Enchanted Forest. In a nutshell here are their definitions.

  • The Secret Society is a group of visionary wealthy people that have insider knowledge of the financial markets. This is not you
  • The Enchanted Forest is where people who think they know something about finances go to lose money. Angel investors, people that claim to be able to beat the market, etc play here. It’s very high risk, and the people playing here have no idea what they’re doing, so they tend to lose their shirts
  • The Capital Kibbutz is where the sane people play. It’s the boring, but successful world of indexing. Resources are pooled in indexing tools to better distribute risk. While you may not make a killing here, you also won’t lose your shirt. At best you will “be” the market, but even that is better than investing with active managers that will cause you to trail the market returns after taking taxes, fees, and inflation into account. He suggests, like most of the wealthy do, for the average person to be here.

I couldn’t agree more.

Gambling is addictive, and the Enchanted Forest world is where you hear a lot of financial professionals lead their clients; it’s unfortunate. Indexing really is the least complicated way to build wealth for most people. It takes some time to do it, but most millennials also have a long time to make it work. Additionally you forgo much of the risk that comes with cherry-picking stocks or trying to time market events.

I don’t know anyone that has Lucas’ level of wealth. But I do know a lot of poor people who play in the Enchanted Forest and who could have been retired by now if they had not.

I was first turned on to indexing by my dad who would listen to Bob Brinker’s “Money Talk” on WLS radio. From there I opened a Vanguard account, started reading Bogle’s work, and the rest is history.

My own portfolio was influence by Brinker, Bogle, and if you can believe this Ben Stein. I have a small book by Ben and Phil DeMuth (I forget which one) that sums up a pretty diversified portfolio in the form of two indexes; the Total Stock index and the Total Bond index.

Those two tools made up the entirety of my investment portfolio during my early years. I added a target date fund to the mix when I began rolling over 401k’s from employers as I switched companies.

To this day they’re served me reasonably well. I don’t look at them much more than once a quarter when I will decide whether to rebalance them. During the remainder of the year I just repeatedly add money to them on a fixed schedule; the stock index on the 1st and 3rd weeks of the month, the bond index on the 2nd and 4th weeks.

Over time, that dollar/cost averaging approach has kept the average cost of the shares in the portfolio low and has caused me to buy all the way through both bull and bear markets. I’m not concerned with the price of the stock index like I might be if I owned individual stocks; it’s a pretty cush’ life.

I’m looking forward to the remainder of the book as I hope to read more details about wealth creation and preservation that I can apply to my own life.

My preferred type of real-estate to own

I am still small-beans when it comes to owning real-estate. It’s clearly more of a hobby for me right now than anything else.

Every now and then I will read an article here-or-there on BiggerPockets about an individual who managed to swing a huge property deal and leverage their way right into the poor house.

I read BiggerPockets so I can better understand what not to do than what to do. We have different financial goals though, and I’m not looking to build a multi-million dollar nest egg; I think it’s a waste of time really.

Being that the following in true

  • Real estate is a hobby
  • I’m not looking to make a killing

I have a different preference for the type of real-estate I own. In particular I prefer places that

  • Have next to zero maintenance
  • By nature of location limit themselves to well funded tenants
  • Are located in areas that I would want to live
  • Have reasonable rules and regulations (locally, as well as in city and state)

To match these criteria my real-estate interests usually come down to the following

  • Townhome or condominium in a Homeowner’s Association

Next to zero maintenance

Property located in an HOA is, usually maintained in large part by the Association.

Things like lawn care, snow removal, driveway patching, roof replacement, siding replacement, and almost all external properties of the home are covered by them.

This is paid for, by you, in the form of an HOA fee. For my property in Aurora IL, the HOA fee is ~$150 per month.

While their coverage of this maintenance is a plus, some HOA’s can take forever to get anything accomplished that is unplanned for. Lots of times this is due to the company that they contract the work out to being a crap company.

Case in point, when the wind blew a piece of siding off my home, it took the HOA 6 months, and three contracted companies to get it replaced. Why so long? Because the contractors went out of business in the process…yes, all three of them. As this was happening, the HOA people responsible for the work order didn’t track the progress of the work nor did they frequently follow-up with me on the state of it.

I was the one who ended up doing all the leg work to make sure that things were fixed appropriately. My tenants at the time were understanding of the situation and I kept in close, frequent, contact with them during that period to reassure them that I was still working the system and not sitting on my laurels. I hate landlords who don’t communicate.

Aside from that one event, maintenance has usually been acceptable. It is my responsibility to maintain everything from the walls inward and for the HOA to maintain everything from the walls outward.

Location breeds well funded tenants

Tenants that don’t pay suck. Legally it takes forever to evict them and that’s not something I care to deal with. I prefer to buy real-estate in more expensive areas because it implicitly disqualifies a certain breed of tenant from even applying in the first place.

Well capitalized tenants have a greater potential to pay their bills on time, but they also have more expensive taste and less tolerance for shoddy maintenance. That being said, you can often

  • command a higher price
  • ultimately own less total properties
  • therefore have to deal with fewer tenants

if you own in expensive areas. Remember that, for me, this is a hobby. If I have to deal with too many tenants, then it becomes a second job and I’m not that interested in making this a second job yet.

Regardless, the locations that attract wealthy people are also the nicer maintained locations to begin with and fall in line with my next point

Located in areas where I would want to live

When I buy something, I ask myself if I would want to live there. Is there too much traffic in the area? Is it located near grocery shopping? What about the aesthetics of the place? Do they charge fees for everything? What is not allowed by the HOA? What is the quality of the amenities? Is it close to public transportation?

There are a host of things that I want in a property. I look at it like this.

What happens if I want to move into it myself after my tenant leaves?

If I wouldn’t personally move into it, then I will not buy it. It is, after all, my house. If I wouldn’t live there, then why would I expect someone else to?

Reasonable rules and regulations

Ok, I get it that when dealing with a bureaucratic entity the notion of “reasonable” is often a pipe-dream. There is, however, a possibility that the local governing bodies have limited the amount of damage they can do to you in the form of fees and paperwork.

For Aurora IL the legalese is rather tame, all things considered. You need to have designated an “agent” if you live more than 50 miles from the property, and you need to have yearly walk-throughs of the property performed by the local housing authorities. The walkthrough costs ~$40 and can be scheduled any time so I just delegate it to my tenant to schedule it around their own schedule.

The “agent” is just a local proxy for you. They don’t need to have any qualifications to be an agent. The only requirement is that they receive mail for you and attend any sessions related to housing practices that might be required. Typically there is a yearly hour long session that they need to sit through, sign their name that they attended, and collect a piece of paper saying they attended; that’s about it.

So an agent could be your mom, dad, your best friend, your brother, sister, their spouse, your real-estate agent or even maintenance guy, etc. The volume of stuff that the agent needs to deal with for Aurora is pretty low so just about anyone can fill the gap; they just need to be able to make it to any events that they might need to attend.

In conclusion

I’m not interested in buying multi-family dwellings and having to deal with 5, 10, or more tenants. By that point in time, the hobby would have become a second business.

Right now I’m interested in 3 tenants max. That seems like a number that I can personally manage (ie, not having a property manager) while at the same time making enough side income to afford my current lifestyle and banking the remainder.

HaaS - Housing as a service

I don’t quite understand where all the hate for renting comes from. I read a lot of financial blogs where the authors claim financial superiority because they own places and poo-poo people who rent places.

I don’t think they’re willing to accept that renting is a very appropriate way of living. In todays “as a service” sort of world where you can get just about anything as a service (cell phones, cars, infrastructure, databases, software, books, movies, the list is endless) these finance people object to “housing as a service” (ie, renting) for reasons that seem silly to me.

There are two people in my family who, relative to the other people in the family, would be considered financially savvy; my uncle and my dad. In all the conversations that I have had with them, the only argument that they can make for owning vs renting a place to live is

When you rent you’re throwing your money away

That’s it.

That also seems to be the pillar that many financial “professionals” like to support their arguments for renting vs owning on.

In my experience though this is a fairly baseless argument to make in the conversation around renting vs owning. The conversation is much deeper than that.

In this post I’m going to dip into some of the differences between owning and renting. There are a TON of questions that you should ask before stepping into any housing situation. The following is a brief list of questions that I have come up with per my own dealings in housing situations.

  • Do you want a home, condo, or townhome?
  • Is the place you’re looking at in an “unincorporated” subdivision?
  • Is it part of an association?
  • Do you want to own it?
  • Do you want to rent it?
  • Is the landlord a person or a company?
  • If a person, does he/she live on the property with you?
  • Do they live in the same city?
  • Do they live in the same state?
  • How long have they been a landlord?
  • Do they have children?
  • Do they have pets?
  • Have the previous tenants had pets?

I’ll stop there because I could easily go on with more questions.

I ask myself these questions before I sign any rental agreement. Some of them may sound silly, such as “Do they have children” or “do they have pets”. But you would be surprised at how much answers to questions like those can affect you over the course of a year.

I’ve been in rentals where the children…grown children mind you…were total assholes to me. They took advantage of my generosity, and made the rental situation a headache.

Suffice to say, I will never rent a place where the landlord has kids. Additionally I’ll never rent a place where the landlord lives on premises. My last experience with this situation left an impression on me because the dude didn’t maintain his property and it was awkward to have him living upstairs. It always felt like I was the third wheel. That somehow I wasn’t welcome because I expected him to fix things when they broke. Totally awkward. Never again.

It’s a trade-off though. Renting a not as bad as some people make it out to be; even if you’re only looking at it from the perspective of money. Depending on the place that you rent or the place that you buy, some of the following may or may not apply to you.

I compiled the following list by comparing the experiences that I’ve had in renting versus the experiences I’ve had in owning.

  • You don’t need to be concerned with any of the miseries of owning a house
    • Maintaining yards, cutting grass, shoveling snow
    • Replacing major appliances such as refrigerators, water heaters, toilets, etc
    • Replacing roofs, windows, repaving driveways or fixing other structural components
    • Servicing appliances such as furnaces, air conditioning units, and water heaters.
    • Dealing with sewer backups due to tree roots and needing to arrange for having clean-outs run, or calling plumbers to re-route out the backup.
    • Following rules of associations you might live in. For instance, being prohibited from putting satellite dishes up, parking cars cars on streets, the number of animals you can own, etc.
    • Paying association fees every month
    • Paying property taxes twice a year, often a substantial amount, and seeing where those taxes are applied even if you don’t agree with their application.
    • Having to deal with politics in the governance of your subdivision. Electing people to the board of directors for the Association, deciding what crap to fix annually, etc.
  • You can often find a place for an amount equal to, or lower than, a home
  • Many rental areas will share common utilities and charge you based on the size of your unit. This in turn can lead to lower utility costs for you if you choose to live in smaller units. Units that you actually fit in instead of units where you are encouraged to fill with useless crap.
  • Your term of residency is not 15 or 30 years. At most it’s 1 year. In fact, it can be even shorter than that if you can pony up the cash to break the lease. While this might look expensive on paper, it’s far cheaper than attempting to break out of a mortgage. Some places will do month-to-month. Some will require an initial 1 year lease but then switch to a month-to-month after that initial year.
  • Getting into your living agreement is trivial by comparison. You don’t need to “go to closing”. You don’t need to hire a lawyer to go over documents. You don’t need to hire a real-estate agent to negotiate with a seller. You don’t need to be concerned with PMI or raising the funds to cover a downpayment.
  • You don’t need to get a loan or concern yourself with significant proof of income and assets to secure a mortgage that will allow you to get the place you want.
  • Most rental places include shared amenities like a pool or fitness center. Contrast that with buying a place where you would need to add those things with your own money and then, in turn, probably never end up using them.
  • There’s no need, or even desire, to put money into renovating the place you rent. The most you’ll probably spend on is to add niceties to the rental that you can take with you when you leave.

I should mention that it really depends on the place you own whether or not you’ll have to deal with some of the same issues. For example, I own a town home in an Association. The Association takes care of external maintenance of the property. This maintenance is non-negotiable though and neither is the payment for it; ~$150 per month.

I like to think that the argument for owning instead of renting is the same as the argument for getting married.

Do it so you can join us in our misery.

Same goes for having kids.

Do it so you can join us in our misery.

Misery loves company, and no American would ever truly speak their mind to you. Instead they would be kind and tow the party line of their fellow Americans; home ownership is the “American Dream”, don’t spoil it for me! The dishonesty is remarkable. It’s as if people are afraid to speak the truth. That they might offend someone or scare them off. I’d prefer the brutal honesty because it’s all that you can go on when making real life decisions. If you are sold a fairy tale, then you’re in for a surprise when you are inevitably confronted with reality.

The pitch for owning a home is never the whole story. Just as the pitch for anything is never the whole story; it’s a pitch.

As for what I do, I rent an apartment. It’s the perfect size for myself and my girlfriend. My cost to rent the place is reasonable, and we have the flexibility to get up and leave at the end of the lease if we want to.

I don’t expect that I will ever own a home, to live in, ever again. I may purchase more real estate in the future, but solely for the purpose of generating income to support lifestyle.

Renting, to me, is the perfect option. You’re not throwing your money away. Instead, you’re paying for the luxury of not having to be a homeowner.

If you’ve never actually owned a home though, you wouldn’t understand where I’m coming from and you’re probably enthusiastically ignorant about the whole process.

I suppose that’s OK though. People need to make mistakes so that they can learn from them. I make mistakes and have learned. The trick is to limit the number of mistakes you make over time.

Discriminating against tenants

I recently read Bruce Schneier’s book Liars and Outliers. In it, he makes use of several models to present topics to the user. One of the models that he presents is taken from Game Theory and concerns Cooperation. It’s called the Hawk-Dove game.

What Bruce says about the model is that “what it illuminates about the real world is profound”. I would certainly agree with that statement.

I’ll describe the game as he does in the book.

The game works like this. Assume a population of individuals with differing survival strategies. Some cooperate and some defect. In the language of the game, the defectors are hawks. They’re aggressive; they attack other individuals, and fight back if attacked. The cooperators are doves. They’re pacific; they share with other doves, and retreat when attacked. You can think about this in terms of animals competing for food. When two doves meet, they cooperate and share food. When a hawk meets a dove, the hawk takes food from the dove. When two hawks meet, they fight and one of them randomly gets the food and the other has some probability of dying from injury.

He continues making various observations on the system as the numbers of doves to hawks is adjusted and it speaks volumes for what we tend to observe in the real world.

If you have too many people (hawks) taking from the system, the system falls apart. But you can’t have a perfect (only doves) system. There will always be some minority of hawks in the system because

  • when it is so easy to defect
  • when the defector is not easily caught
  • and when the defector doesn’t place a real burden on the society

…some people will evaluate the risk/reward in their minds and choose to defect.

Profound!

The Hawk-Dove game is a model that can be applied to many scenarios. In this post we’ll apply it to Renting.

Discrimination in housing is done all the time. If you think otherwise, you’re delusional.

Landlords, like most people, know that stereotypes tend to be accurate for a reason. There is empirical social science research which shows that stereotypes are often accurate.

The fact of the matter is that while you might, on the surface, claim that you never have these thoughts in your mind, the reality is that you do. So stop being fake about it.

Landlords also know that they can discriminate against you all day long and there’s nothing that you can do about it. Why you ask? Because they can always find a legitimate reason to claim that they denied you, and they know they won’t be challenged on it.

I’ll give you a real life example.

A colleague I worked with owned a property that he rented out. When the time would come to find a new tenant, there were some people that they just wouldn’t rent to. Period. Even the upper-class versions of these people were, in their mind, considered to be too risky to rent to due to how they might treat the property and the costs, to the landlord, of fixing those things.

For example, they wouldn’t rent to Indians. Ever. When an indian tenant would apply, they would accept their application but would be very critical of the applicants credit, work history, criminal background, references, or similar screening standards.

For instance, if they were listing the place for $2000/month, they would stand firm on that price; non-negotiable.

In turn the types of people they specifically didn’t want renting their property would often just skip renting the place (much to my colleagues’ joy).

A lot of discrimination happens in a “don’t ask, don’t tell” sort of way and those who are discriminated against will often just suck it up and move on. In most areas of the country, there are numerous other options to satisfy them. It’s easier to just clam up and go find a different place than it is to make a big deal out of it or to “make an example” of the person doing the discriminating.

For your own sanity I’d suggest that you not emotionally invest yourself in any particular place. Be prepared to be discriminated against.

To help make it less of a burden on you, have some foresight into the process. If you know you’re going to need to find a new place in the future, then start preparing for that transition long before it happens. Just because others might be going out of their way to be a jerk to you doesn’t mean that you need to sit there and be a victim.

You’re going to be discriminated against. Deal with it. I’ve been discriminated against in my life and I’m an “American White Male”; a class that is considered by some to be the top of the social ladder. If it happens to us, then it can happen to anyone.

What I’ve found to be helpful is to develop, as they say, an “Attitude of Gratitude”. Also, be sure to back it up with accountability and action. Walk the walk. Don’t just talk the talk.

It’s a fact of life that there are hawks who will try to take advantage of your dove. It has been my experience though that many of those hawks can be turned to doves if you’re persistent and raise your standards of what you expect from them.

I’ve cracked a few tough nuts in my professional career, as well as my personal life. Make those people your hobby. Whiners and the non-committed need not apply.

Landlord, not slumlord

In October of 2008 I had just turned 25 years old and had purchased my first home.

List price was $215,000 and I got the place for $199,000. It was a swank little place in the suburbs west of Chicago. I lived about 30 minutes from my mom’s house and it was relatively close to work.

I lived there for a couple years going through the typical cycle of “work, sleep, repeat” for a couple years. Everything was going fine and dandy, but I was frustrated with my career path.

I had been working at my job for a little more than 7 years and I wanted something more. I was uncomfortable thinking that “this is it”, that I had accomplished all there was left to accomplish in life and now I just needed to wait things out until I kicked the bucket.

I started flexing my LinkedIn profile and as luck would have it, landed a job at Rackspace in San Antonio Texas in 2013. I was moving south, far far away from Illinois. What was I going to do about the house though?

We have a family friend who is a real-estate agent and she made it perfectly clear what we could do; rent the house. She and I worked together and before I left Chicagoland, I had the place rented. I was officially a landlord.

It’s now been almost 3 years since I started this whole remote landlord gig and in that time I’ve had quite a few learning experiences. They’ve led me to operate my business in a certain way and I wanted to reflect on what those values and goals in my real-estate business are.

But first, some context.

I have an immense interest in finance and all things money. Perhaps it’s that my dad is the CFO of a bank and did corporate tax for most of his professional career; who knows. I don’t specifically remember him ever being real talkative about money or finances. He would buy me books on the subject if I asked for them for Christmas or a birthday, but I don’t remember having open conversations with him about money.

In terms of real-estate influencers in my circle of family and friends, there really is only the family friend who is a real-estate agent (she also owns three properties herself) and an aunt I have who is a landlord. My aunt, from what I hear, tends to run her business with an iron first, a value I do not share.

Aside from that, I can’t think of other influencers in this space.

I am a strong believer in the Golden Rule and an even bigger believer in the Platinum Rule. If you haven’t heard of the Platinum Rule, it goes something like this

Treat others the way __they__ want to be treated.

Contrast this with the Golden Rule that goes something like this

Treat others the way __you__ want to be treated.

How do you know how others want to be treated? Easy. You can ask them. Or, you can begin working with them and based on your interaction with them you can basically just “figure out” what they want. Most people will reveal their wants/needs to you indirectly the more you interact with them. You can always test these wants by doing something that has the potential to fulfill a want. Observe their reaction. Then repeat as needed.

Regardless of which rule you identify with more, the point is that this is one of the values that I identify with and one that I personally want to express in my business ventures.

Rackspace represented this beautifully in what they called “Fanatical Support”. Really, that’s the cornerstone of my values system that I want to imbue in my business dealings. To that end, I treat my customers (my tenants) with respect and do my best to provide them with Fanatical Support.

To do that, I need tenants who will provide me with the same respect.

  • Take care of my property
  • Report broken things immediately
  • Pay your rent on time

It’s not that complicated. Do that, and we’ll get along just fine.

I tend to not have riders in my lease agreements about rent increases. Frankly, I don’t really need the money. I’m completely debt free. I make decent money. I’m in this to create a business model that puts the customer, and service, first. I think that this will result in profit.

A happy tenant is a priority of mine. Why? Because I want to be a happy tenant. When I have a great working relationship with my leasing coordinator and my maintenance folks at wherever I live, I’m smitten.

I could be wrong about many of these processes that I’m aiming to implement in my business ventures, but I’m hopeful that I’m not. Taking advantage of people just to turn a profit is, in my opinion, wrong. I like to think that I can be an example to my family and friends of how to do things with integrity and excellence.