Q&A: We Save $5,000 Per Month. Where Should We Invest It?

29:00Let's name her Adrienne. All right, great. Then the next question comes from Adrienne. Hi, Paula. I'm looking for help deciding whether or not I should sell or keep and rent my condo in the midst of rising HOA costs. When I originally purchased the condo, I thought it would be a great unit to one day rent as it is in a very walkable area with a lot of new development, including restaurants and retail. My husband and I would now like to purchase a single family home in late 2024 to prepare for starting a family, but now I am unsure what the best strategy is for our condo. Here are the details. The condo is a thousand square foot, two bed, two bath, purchased for 385k at a 3 % interest rate.

29:44My current mortgage payment is$1420 with$265k left on the mortgage. When I first purchased the condo, the HOA fees were$350 a month, but now they have risen to$640 a month in 2024. The HOA fee covers water, gas, trash, maintenance, landscaping, snow removal, insurance, and management fees. And almost all of these budget line items have significantly increased over the last few years. Additionally, we had a major plumbing repair, which drained our community reserves and resulted in a small special assessment. So the higher dues are also going towards rebuilding our reserves in anticipation of a boiler replacement in about five years.

30:30My neighbor recently rented out a comparable unit for$2 ,350 a month, including all utilities except electric. If I were to rent my unit out for a similar amount, my cash flow would be very tight based on my current mortgage and HOA, plus possible management fees and vacancies. On the other hand, the current Zillow estimate for my condo is$440K. I am concerned that the rising monthly fee and recent special assessment would be a red flag to any buyers, so I assume I would have to make some concessions and would end up selling a little bit lower. What would you do in this situation? Thank you. Adrienne, thank you for the question.

31:11First of all, congratulations on owning the condo, Congratulations on being at the cusp of taking that next step in life. So should you sell or should you rent? Here's what I want you to do in order to answer this question. I want you to open a spreadsheet and calculate something that's referred to as the cap rate. Now the cap rate to zoom out and give a framework of what this is and why this matters. I'm going to really zoom out here. Any asset makes money in two ways. There's capital appreciation, which is the rise in value, and then there's the dividend or the income stream that it pays out.

31:52So a share of Coca-Cola stock, for example, rises, hopefully rises in value over time. That's the appreciation and also has some type of a dividend payment. A house or a property, in your case, a condo is no different. the condo has some level of appreciation and it also has a dividend or an income stream. Now, what you want to do is you want to figure out what that dividend or that income stream is. And so the way that you calculate that number is first, you calculate all of the revenue that your particular condo could collect. So the rental income, I don't know if there's a parking spot associated with that condo, but if you charge extra for the parking spot, that would be additional income as well.

32:39Any income, if you charge a pet fee, if you decide that you're going to charge maybe an extra$50 per month as pet fee, layer that in. So first project all of the revenue, not just the base rent, but parking fees, pet fees, laundry fees. Maybe the building has a separate storage unit and you would charge for access to that. Any and all revenue, right? calculate all of that together. That is the potential gross revenue that you could collect. Then you start subtracting all of the expenses. So subtract estimated vacancy, subtract out estimated repairs, maintenance, CapEx, the HOA, subtract all of that out.

33:26What you're left with is a number that is called the net operating income, right? Now, the one thing that you are not subtracting, let me make this very, very clear. The one number that you are not subtracting out is the principal and interest portion of your mortgage payment. That does not go into the formula. And we'll talk about why in a moment. You will subtract out the insurance costs on the condo. You will subtract out the property taxes on the condo. But the financing, the debt financing, the principal and interest portion, that does not get subtracted, right? So you take the revenue minus operating expenses equals net operating income.

34:10Net operating income divided by the purchase price of the property, the price that you paid for it, that number expressed as a percentage is your cap rate. Now, the reason that you want to calculate this cap rate is because you want to find out what type of unleveraged return you would be getting on this condo. And to figure out that unleveraged return, you look at the cap rate. That cap rate is the equivalent of the dividend that you are collecting. And that dividend plus your estimate for capital appreciation, those two together constitute your total return. So for example, let's say that your cap rate ends up being 5 % and you also estimate that over time the condo will rise in value by, we'll say, 4 % per year.

35:04That means that your unleveraged total return would be 9%. That would be 5 % as the dividend that you're collecting plus an additional 4 % as your estimate for appreciation. There will likely be a range. As you're making these estimates, you're going to estimate a range for what you think the repairs, the maintenance, the capital expenditures, the vacancy, possibilities for capital appreciation, maybe 3%, 4%, 5%. Don't conflate precision with accuracy. You might calculate a worst case, best case, and medium case scenario. But you want to calculate this range of what you think the unleveraged return will be.

35:45And then take a look at that return and ask yourself, is that a return that I want relative to the amount of risk that this condo carries? And when I say risk, I'm talking about the risk of vacancy, the risk of high levels of turnover, the risk of multiple calamitous repairs and quick succession such that the CapEx becomes greater than your cash reserves can float. Those are the risks that you face. So what are the returns? relative to the risks. And based on that, you know whether or not this is an investment that's worth holding. And you'll also know whether or not it's worth borrowing money at whatever percentage your mortgage is.

36:29You'll also know whether or not it's worth borrowing money at X percent in order to obtain a total return of Y percent. But you need to calculate cap rate in order to answer those questions. Fabulous. I love any time that we'll make these decisions based on math. It's truly an emotional place where you are. I have this condo. A lot of people answer that through an emotional filter system. Right. Right. Exactly. And with something like the HOA fee, that is a much maligned fee. People hate paying high HOA fees, but you never hear the same level of discussion about the fact that, as she stated in her question, the fact that people who own single family homes that are not HOA governed, so homeowners who do not have HOA fees, they often pay higher property tax rates, higher insurance rates, higher water and sewer.

37:36Right. Water, sewer, trash, electricity. Exactly. Exactly. Right. Those fees go up. One thing that I want to applaud Adrian for is that in her question, in the way that she talked about the HOA fee, it's clear that she understands that the reason that the HOA fee rose is because it covers all of these costs that have risen. And many other people out there in the world, unfortunately, don't because it's very easy to just look at an HOA fee and say, wait a minute. What does this rip off? Yeah, my building doesn't have a pool. What does this cover? You know, like forgetting about all of the invisible costs like sewer.

38:18It seems like you might be able to know if your HOA fee, if they are taking maybe more than what you would want by looking at comparable people in the neighborhood. Because I believe if it's a municipality that's managing these systems, I should be able to know what these individual rates are and do kind of another back of the envelope calculation. Right. But in a condo building, you also have common areas. There are elevators that need to be maintained. and when you get out of the elevator, there's a hallway and that hallway has to be air conditioned. It has to be heated. It has to be cleaned.

38:54It has to be occasionally repainted. It has light fixtures that need to be changed out. I'm not saying it'd be one-to-one. I'm just saying I can list these things that I get for myself and then I can think about those common areas and whatever and go, okay, yeah, yeah, I can, I can totally see this fee or I can go what, what the heck. And then I've got some interesting questions to ask the homeowners association. How does this break down? What's this for? Well, HOAs always publish their budgets. Any homeowner who pays an HOA fee can get a copy of the HOA budget. So you don't even have to do the math.

39:29You can just ask for a copy of the budget. Even easier. As much as people like to fixate on HOA costs, people often don't give that same level of attention to utility costs. And utility costs rise. That's just what they tend to do over time. You heard it here first, people. Adrian, to go back to your question, calculate a range of cap rates. Calculate a worst, best, and middle case scenario based on your assumptions around all of these various operating expenses. and then add that cap rate to your projection of how much you think that the property value will rise through market-based appreciation.

40:15And that's your unleveraged total return, which is just a fancy way of saying, if you held the place in cash, if you held the place free and clear, that's what the return would be. And by the way, the reason that I'm saying that, you said something in your question that raised a little bit of a red flag for me. It's when you said that your cash flow after paying your mortgage and everything would be negligible. Obviously, you want the cash flow to be positive. A lot of investors set a goal of$100 per door. For a lot of investors, that's their goal when they're going out and trying to find a property.

40:50And that's because they understand that a lot of the return comes from principal pay down. You're getting tenants to pay off the mortgage. Therefore, you're growing equity and growing your net worth, and that's coming out of the rent that you're collecting. You are getting, over time, higher and higher rent. Rent tends to rise at the rate of inflation, but your mortgage, if it's a fixed rate mortgage, stays the same. So that delta increases over time, right? So you're getting increasing revenue on a fixed debt expense, right? Investors understand that the financial benefits of owning a rental property are not necessarily reflected in the cash flow in year one.

41:44Cash flow in year one is a very negligible part of the overall benefit, the overall return that you get on a rental property. And that's the reason why calculating the cap rate is a much better way of understanding what kind of return am I actually getting? What kind of return does this asset yield if it were to be held free and clear? And once you know that, then you can decide, does financing at this given interest rate justify this other given return that I'm receiving? By the way, notice the thing that I'm not talking about. I'm not talking about – there's a different formula. It's called cash-on-cash return.

42:26This other formula is very popular among real estate investors. I do not like it because the formula cash-on-cash return is designed to reward maximum levels of debt. Yeah, exactly. The formula of cash on cash return asks the question, what kind of return am I getting relative to the amount of my money that I've put into the deal? I hate looking at it like that because when you look at it through that framework, you are necessarily setting yourself up into a question that rewards putting the least amount of your money into the deal, meaning borrowing the max. right? If you put$0 into the deal, your returns would be infinity.

43:08And you should be inherently suspicious of any formula that tells you that your returns are infinity. So I am not a fan of the cash on cash return formula. I'm a huge, huge fan of the cap rate formula, where you understand if I held this free and clear, what would the returns be? And you can evaluate the asset itself absent of any financing considerations, right? And once you know that the asset itself is a good deal or a bad deal, meaning does it have a good risk-adjusted return or not relative to the amount of risk that that particular asset holds, vacancy risk, tenant risk, et cetera, then you can make a financing decision.

43:51But I like the idea of evaluating the asset itself inherently first before you then turn your attention to financing. That's the reason that I'm a huge fan of cap rate and also the reason that I despise as maybe too strong of a word, but really, really dislike the cash on cash return formula. So, Adrian, there's your answer. Ta-da! I couldn't have said it better myself. You ran with Eugene's question about insurance products and choosing a financial advisor. so it was my time to run with adrian's question around should i sell or should i rent yeah i feel like we're handing off the baton today and when i say i couldn't have said it better myself i totally mean i couldn't have said it i couldn't have said any of that all right well thank you adrian for the question this episode is brought to you by progressive insurance do you ever think about switching insurance companies to see if you could save some cash?

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46:56Joe, it's time. It's time for the question that we have been building to. The featured question. The featured, today's featured question. And this question comes from a listener who saves$5 ,000 per month after taxes. And she wants to know, how should she invest this money? What accounts should she put this in? Where should this go? This caller, her name is Nandini. Let's hear her question. Hi, Paula and Joe. My name is Nandini. I really enjoy listening to your podcast and recommended it to so many of my friends and family. As an immigrant, I was struggling to understand even basic things in financial investing, and your podcast helped me a lot.

47:47My question today is, my husband and I saves roughly about$5 ,000 post tax per each month. I'm looking for ways to invest this money. We don't have any kids yet. We both are currently doing employer match for 401k, max out our HSA, 10 % of our salary for ESPP. We also max out backdoor Roth IRA. The only debt we have is home mortgage which is 390k with 3.8 % interest. We also have a cash of 50k in high yield savings account with 4.3%. Here are some investment options I thought about. Since we both are not maxing out our 401k and we do have both traditional and Roth 401k options. So the one way to invest is to maximize our 401k.

48:42Our companies also offer mega backdoor Roth with the limit of 44k. The second option is to invest in index funds or mutual funds but since we both are very busy and not able to spend a lot of time in research of funds we are thinking of picking some easy index funds like S &P 500 and invest monthly. Apart from these two options Can you think of any other suggestions? I appreciate both of your valuable input on this. Thank you. Nandini, thank you for the question. This is such a good question. And I want to take a moment to expand this to everyone who's listening, because fundamentally your question is, I'm saving money.

49:26Where should it go? I'm saving money. Should it go to a 401k? Should it go to a mega backdoor Roth? Should it go into a taxable brokerage account? So much of personal finance fundamentals focuses on the step that you're already doing, which is saving. And by saving, I mean having a gap between what you earn and what you spend, right? You're already saving$5 ,000 a month. You've got a gap of$5 ,000 a month between income and expenses. Fabulous. Right? That is incredible. That is so great. So much of personal finance focuses on encouraging people to do that without ever addressing the follow-up question of what do I do with that money?

50:20That's why I love your question. So let's talk about what to do with that money. First of all, you're maxing out your health savings accounts. Both you and your husband are maxing out your health savings accounts. Incredible. Amazing. Keep doing that. don't stop. The reason for that is because health savings accounts, HSAs, have a triple tax benefit. You get a tax benefit on the money that goes into the account. You get a tax benefit on the money while it's in the account. And then you get a tax benefit on the money when you spend it. So triple tax benefit. Health savings accounts are absolutely fantastic.

50:57Love it. The next thing that I would say is I love the fact that you are totally debt free other than a mortgage that has a very, very reasonable interest rate. I love the fact that the money in your high yield savings account is earning an interest rate that is higher than the interest rate that you're paying on your mortgage. How cool is that? Money in a savings. Can we pause and think about what that means for the society that we live in, what that says about how quickly inflation has risen and how quickly interest rates have gone up as a result, that a person can have a mortgage rate, a fixed rate mortgage that is at a lower interest rate than the money that's in their savings account.

51:44Right? Wow. And I'm sure that there are thousands of people who are listening to this who are in the same spot where money in your savings account, money in a high yield savings account is making money at a higher rate than your mortgage interest rate. It's incredible. It's a strange time in history. Yeah, it is. It is a unique time in history. What I would recommend for you is to maximize any type of Roth account that you can access. So you talked about two different types. You said that you have access to a Roth 401k, through work and you also have access to a mega backdoor Roth. Also through work.

52:26Yeah, also through work. I would put as much money into Roth accounts as possible. And the reason for that is, although you do take the tax hit now, all of your gains, your capital gains, your dividend income, every gain grows tax exempt. And if you think about the power of compounding over the decades and the power of growth over the decades, that is an incredible amount of money that grows tax exempt. So the more money that you can put into a Roth account, assuming that that money is invested for the long term, that that money is going to be there for decades and decades to come. you pay essentially a small fee right now, that fee being your current this year's tax bill, in order to have decades and decades of tax-exempt growth.

53:20It's an incredible opportunity. So make the most of that. I love the bias toward the Roth. And I love that that second piece after the HSA is 401k. And I also like that for people starting out to the employer match because if you're just beginning the employer match, it's free money. And even if you have goals that are different than for retirement, I would never give away free money. So always put money in the 401k up to the employer match. You're going to need that money anyway. If you have any type of financial independence goal, it's a great idea to backfill, Meaning look at the later years of your life first and make sure you're going to be secure in those later years.

54:07So if you're in your 20s, you're starting out. Let's make sure you're going to be fine in your 90s. Let's put some money toward that so that your freedom from worry, you're able to move forward. And then over time, then it'll be that you're safe in your 80s, then your 70s, then your 60s, then hopefully your 50s that you're safe. Right. But I like this idea of backfilling because the more you have a bias toward not just the Roth, but also toward your long-term goals versus the short-term stuff, then your money gets to work for you. I think I first read about this in Rich Dad, Poor Dad, Paula. The idea that your money is like another you that takes its lunch to work every day.

54:51And I get really excited about that analogy because I'm as lazy as the next person. And if I can skip work on a day, but my money every day goes to work and works and makes money on top of the money. I mean, that's fantastic. So the quicker I can get my money earning a living wage, the better. And I love that. And that's why I like backfilling those. So my bias, I have two biases in my order of operations. Bias number one is emphasize long-term over short-term. bias number two then is if i'm going to use debt i'm going to try not to but i'm going to more likely think about debt to fill in my short-term things than i am the long-term stuff in other words a lot of people will make sure that their kids college fund is saved for before they get themselves to financial independence i look at that the opposite way i think paula you look at that the opposite way.

55:51There are plenty of ways to get junior or yourself through college. Some of them involve debt. There is no loan program toward financial independence. So if I'm going to go into debt, it's going to be for some of the shorter term stuff. This is really important though, Paula. And I think it's because of the fact that just as humans, we tend to look at the next thing coming up and we want to make sure we're going to feel okay when we get to that moment. I love using the psychology of imagining myself being 65 years old and I haven't done a thing for those long-term goals. I let myself feel that feeling.

56:33And when I feel that little bit of fear, I'm not really fear motivated, but when I feel that little bit of fear, it helps me get beyond this short-term problem that I'm experiencing that I want all my money to go towards so I feel okay today and instead put me in a spot that makes sure that I'm going to feel good later on. You know, there are apps where to the point of imagining that you're 65 and imagining what the 65-year-old version of yourself would want the you of today to be doing. There are these apps where you can digitally age your face. And there's actually research that shows that people who do that save more money for retirement.

57:14If you can imagine yourself in retirement, which you can do by seeing a picture of your digitally aged face, then you have a visual image of the person that you are saving for. After those basics, then I think we get to your goals. And if you begin with the end in mind, we can then build a plan that is based on how much money does each goal require. And we're never going to know exactly, right? Things are going to change. The goals are going to change. And that's why we call it planning and not a plan. A plan is worthless the second it's printed. But the idea of planning as you go is going to help you move as the river moves.

58:00You're going to flow like the river. So whether you put money in non IRA positions or in the 401k are going to be based on how many goals you have before you can get at that 401k slash IRA money. We want to have some flexible money so that you're able to save for those separately. So if it's a new home, if it's some goal to take more time off work to do the things, take a sabbatical, certainly I wouldn't put that money in your 401k. I wouldn't use 401k loans at all. I'd stay away from those. Those are nasty for a variety of reasons. But I think that that bias toward the Roth bias toward long-term.

58:45And then once you do that, HSA Roth, long-term money, take the match, then look at your goals and now put money in the appropriate pots. I'll say this too, specifically about what Nandini was talking about, which is I wouldn't even look at the mega backdoor Roth option through work until just the straightforward Roth 401k is fully funded. because Paula, that money's all going toward the same pot and it's so much easier to not have the two or three steps to get the mega backdoor Roth where you want it to be versus just max fund the Roth 401k. I see people do backdoor Roths often when they have the Roth 401k available and they're not max funding the Roth 401k and they're going through all these tax gyrations.

59:41max fund the Roth 401k first. It's just going to make your life a ton easier. So Joe, you never did answer the question, what accounts do you save in first? I save specifically into pot based on what the goals are. So we save into Roth 401k. I do not have an HSA available. You've got one of those good health insurance plans. Right. Low deductible. Yes, we do. I feel very lucky there. Save into the Roth 401k first. Then I save into a variety of non IRA spots, but I save specifically, Paul, for the goal. So I have a fund for my next car. I have a fund for home improvements. By the way, I use an Ally Bank savings account.

1:00:33There's other companies that do this. But I like it that I have one high yield savings account like Nandini has, but I have separate buckets inside of the same high yield savings account. And Cheryl and I can put names on it. This is the car money. This is our money for our home addition. This is money for next year stuff. So all the plans that we have are separated so that I'm not spilling over into a different bucket. Behaviorally, I love that. And then it does make sense. every account that you choose would be tethered to a given timeline. And then it makes it easy. Then much like Nandini, I pick the index that fits the goal.

1:01:12It's super easy. And by the way, Nandini, that's the perfect way to do it. When you say you don't have a lot of time for research, the only thing you need to research is what's the amount of money I need to reach that goal and which index is the appropriate place to get me there. Period. Full stop. Yeah, exactly. In fact, it's not even what index, but just if you want to keep it super simple, one total stock market index fund, one total bond market index fund, then the only question is what proportion of each one fits this particular timeline? If you want to make it super simple, just do that.

1:01:51Yeah, good night. Right. Well, speaking of good night, I think we've done it again, Joe. No, say it ain't so. It is so. And Nandini, thank you so much for the question. Joe, where can people find you if they would like to hear more of you? You can find me and sometimes the amazing Paula Pant. Usually I'm Fridays with Paula. Monday, Wednesday, Friday, though, for me at the Stacking Benjamin Show, which we call the greatest money show on earth because on Mondays we have great mentors. On Wednesdays we dive into one or two very specific tactics. And then on Wednesday, we have a wonderful roundtable discussion with Paula Pant, the award-winning Len Penzo, and a, what would you call it, a turnstile of interesting guests on a roundtable.

1:02:40A rotating cast of characters. Of characters. And usually very knowledgeable characters that we've curated to duke it out with Paula and Len and OG. And you recently aired, a couple of weeks ago, you recently aired episode 1500. So while we over at Afford Anything, we're celebrating episode 500, which is coming up next week. You guys just celebrated episode 1500. I wasn't going to bring that up. For the math majors here, that's three times more. Wow. it's funny because we have had a lot of episodes and I feel very grateful for uh this uh community um there's a guy that I know who uh Glenn Hebert's his name Paula he runs the horse radio network they go five days a week and when he heard we were on episode 1500 he's on episode like 4000 And he's one of the few people that can go, oh, how cute.

1:03:42He literally said, Joe, that's so cute. 1500. Good for you, beginner guy. That's funny because isn't there some statistic? Most podcasts fade after like episode. Jeez. Seven. Wow. People discover how much work it is and then they're like, nope. They just nope out of that. It blows me away how much work it is. Doesn't it blow you away? It's great work. I love it. But there's a lot more behind the scenes than anybody would expect. Yeah, absolutely. But I am thrilled that you hit episode 1500 and we hit episode 500 in the same month. So April 2024 was the month of Afford Anything episode 500, Stacking Benjamin's episode 1500.

1:04:27I feel like there's got to be some, you know, the stars align. Well, you're celebrating at a comedy club. And I said this before we started. We did our comedy club tour. So again, Paula, how cute. For our episode 1000, we celebrated with a lot of different podcasters and heard from a lot of different voices from the personal finance community, which I was grateful for. this 1500 people want to go back and listen you len and og and doug and i just talk about all the years of stacky benjamin some of the funny stories from the past and we have stackers that call in and that have called in and tell us how their life has changed because they've listened so we go back and forth between the history lesson of how was the show made how has it changed, you know, a comedy of errors that we've done along the way.

1:05:22And just all along the way, how hopefully, you know, much like the Afford Anything show that we're hopefully helping people change lives. Well, I, I would love to hear from afforders, afforders, please call in and tell us affordanything.com slash voicemail, call in and tell us what the show has meant to you. And we will, well, we, we've already recorded episode 500, so it won't air for that episode, but I would love to play that on a future episode. All right. Well, thank you so much for tuning in. This is the Afford Anything podcast. Make sure that you're following us in your favorite podcast playing app so that you don't miss episode 500.

1:05:59And I'd like to give a warm embrace to episode 499, which is this one, and all of the 499 episodes that have come before it. Goodbye to the 400s. It's been amazing. It's been real. I'm so excited to enter into the 500s. Again, make Make sure you're following us in your favorite podcast player. While you're there, please give us a rating and a review. Recommend us to your friends. And I'll see you next week. I'm Paula Pant. I'm Joe Solzhi. And we will catch you in the next episode. Because one of our callers has that exact question. Where should she save first? That is really hard to say. Where should she shave sea shells, stop by the seashore?

1:06:51Worcestershire. If she shave sea shells, stop by the seashore. Worcestershire. You know, the sauce, the Worcestershire. Worcestershire. Worcestershire? Worcestershire. Where should she shave first?