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Retirement Strategies REdux: Old School v. My Way April 21, 2008

Posted by shaferfinancial in Uncategorized.
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Mary and Joe are typical folks, they have about twenty years to retirement with two kids fast approaching needing money to attend college.  Joe has been fortunate and has had the same job for over 15 years, while Mary works part-time for a local business and still does the majority of taking care of the kids.  They have accumulated around $100,000 in a 401K and owe $100,000 on a home that is worth $300,000 by aggressively paying off the mortgage and owning the home for 15 years.  Their emergency fund is meager at $8,000.  They know they need to figure out a way to get more money for retirement, but frankly, are at a loss how.  They make an appointment with John, the financial planner.  Mary pulls up in a 7 year old Honda minivan and waits for her husband.  Joe running a few minutes late pulls up in a 4 year old Chrysler 300.  Joe parks next to a new Lexus and admires it as they go into the office.  John meets them at the door and acknowledges Joe looking at the Lexus and mentions he has just leased it a few weeks ago.  Joe is impressed.

John, takes all their information and runs the numbers.  He looks them in the eye and delivers the bad news.  At their present rate they will not have enough to retire on.  They need to do something now!  Mary and Joe are a little embarassed about their situation, but they thought they were doing the right thing, paying off their mortgage and putting 8% of Joe’s salary in to the 401K.  Frankly, Mary knows because the wives talk about this, that they are better off than most of their friends.  So she is a little peeved at John’s rather cavalier attitude toward their retirement savings.  Then John throws in the kicker.  He can help them achieve success.  He starts to talk about asset allocation mentioning that they have all their money in one mutual fund.  He pulls out a prospectus that is for an international mutual fund that returned 28% last year.  Joe is impresses as he knows his fund returned a meager 3% last year.  Then Joe pulls out another prospectus for a Precious Metals Mutual Fund that returned 85% last year.  Joe is fully impressed now.  John suggests he take control of the $100,000 in the 401K to manage it.  He tells the couple to keep up the good work paying off the mortgage, but they need to put away more, much more if they want to retire comfortably.  John also suggests they need some life insurance so he suggests a $250,000 10 year term insurance which he says is dirt cheap now.  Joe and Mary look at each other with the same thought.  They are already pretty thrifty, but there goes the one night a week they eat out together and maybe Mary could work more hours after all the kids are old enough that they don’t need Mary to be there when they get home from school.  But, if that is what they need to do, then they will figure it out.

On the way home Joe is sold but Mary has some doubt about John.  She remembers reading “The Millionaire Next Door” in her book club a few years back, so she is not impressed with John’s car.  Her intuition also tells her that the returns that he showed them for those two funds were a little high, they must be risky she thought.  She thinks  they should talk to someone else.

Can you spot the mistakes?

1.  The assumption that leasing a nice car means that you know what you are doing financially is incorrect and probably the exact opposite.

2.  Mutual funds as a class underperform the market and specialized mutual funds have even more variability which means that those two mutual funds will probably underperform for many years to come to make up for their amazing performance last year.

3.  They use little leverage on their finances and are decreasing it by paying off their mortgage.

4. The majority of their net worth is home equity which gets a 0% rate of return.

5.  Suggesting to a frugal couple that they need to be more frugal is like throwing gasoline onto a fire.  They drive older cars, eat out only once a week and work 1 1/2 jobs between them while caring for two kids.  Life shouldn’t be this onerous for this couple.

My Way:

Move their 401K money to a discount brokerage account and buy $100,000 of Berkshire Hathaway B’s.  Warren Buffett’s returns 21% over 43 years and 18% over  the last 10 years.

Re-finance their home with a $250,000 mortgage now available at 5.75%.  This gives them $150,000 cash.

Take $25,000 and purchase a $200,000 duplex in Dallas, Texas that is cash  flow positive (See my Friend Jeff www.bawldguy.com for details)

Purchase a $450,000 equity index life insurance contract.  Fund it with $25,000 year for five payments.

Reduce the 401K amount to the 3% company match to cover the extra expense of the larger mortgage.

Place the $100,000 left over into a money market fund or high paying savings account to act as an emergency fund and reserve fund for the real estate.

As each year goes by make the $25,000 life insurance premium payment. 

Taxable income goes down as the mortgage interest goes up substantially and the real estate investment throws off tax advantages.

Let’s look down the road five years.  The real estate investment has a cash flow of +$3,000, +$3,000, +$4,000, +$5,000, +$6,000 as rent could be increased.  This $21,000 is held as reserves for deferred maintenance and is not counted for assets.  College aid was applied for the kids and this amount was not counted!

The insurance contract has a cash surrender value of $110,000 since the front loaded fee’s have been paid.  But this works as the couple’s emergency fund available to them with no tax consequences.  The big positive is that this is not counted toward income or assets for college aid.  So they have moved over $100,000 off the college aid books allowing the kids to qualify for more aid.

The Brokerage 401K is worth $228,776 with Warren Buffett continuing the 18% he got the last decade.

The duplex is worth $250,000 getting slightly less than 5% return. They have around $80,000 in equity.

Their home is worth $380,000 getting the same 5% return.  They have over $150,000 is equity.

Their taxes have gone down due to the mortgage interest deduction and the investment real estate.

Their passive income from the real estate is 500/month.

Their kids received large amounts of student aid for college.

They have a emergency fund/reserves over $130,000 so they sleep well at night.

The costs to do this was $5,000 for the refinance, $5,000 to buy the duplex, $12 to buy the stock, and the commission and fee’s for the insurance contract.

There are no ongoing fee’s (other than the insurance contract) payable to a financial planner.

No reduction in life style needed.  In fact as the couples net worth rose, they started to take a nice vacation once a year and Mary will stop working  as soon as the kids are out of college.

Old School V. My Way:  You make the choice!

PS  I used conservative numbers all the way through my way!

PSS  As usual this should not be construed as financial advice with respect to any particular stock or any general investment advice that might come under the auspice of the SEC.  It is only the ramblings of a derelect and a individual that does not have a license to issue stock or mutual fund or real estate advice.  Please see an “expert” for all tax issues.  


1. joetaxpayerblog - April 21, 2008

Is the assumption that the market will continue to present Buffet the opportunity to continue to return 18% ‘conservative’? How is BH different than a mutual fund with an excellent manager? If this were so, why invest anywhere else? I’d be happy to double my money every 4 years.

2. shaferfinancial - April 21, 2008

Over the last 43 years Buffett has averaged 21% return on book value. For the last 10 years over 18%. So I took the lower of the two. You can join the large group of folks saying that Buffett can’t continue to do it into the future if you want. This is the same group that said he couldn’t continue to do it 10 years ago when he avoided tech stocks. Bottom line is he has a 43 year history of doubling the return of the S & P 500 Index including dividends. I started investing with him 10 years ago. Wish I started well before that. Wish I had switched all my 401K money to him then too. Oh well…

As to other money managers. One can only state the obvious. His methods are better than their methods and his results are and have been better. Name one other active manager with at least 15 years behind them who has done better? Can’t because there isn’t one.

Why invest anywhere else? That is the question I have been asking myself for awhile now! If you want to invest in equities then you have to ask yourself that question?

Maybe there is someone out there that can get it done, but how do you know, out of a universe of 1000’s of money managers, which one is it. I know that he has done it.

3. BawldGuy Talking - April 22, 2008

David — Absolutely stellar in every way. Sometimes the whole ‘planning for retirement’ gig is made too complex by over thinking. It’s all about results, and doing things on purpose, as you teach.

I’m not sure I’d like to bet on my retirement by doubting Uncle Warren’s ability to continue doing what he’s been doing since LBJ was in office. 🙂

In my opinion, it’ll snow at noon on an August day in Death Valley before Mr. Buffet loses his touch. 🙂

And the real estate? As long as folks keep in mind the secret — which is to eschew getting rich quickly, and embrace getting rich slowly, a magnificently abundant retirement can be theirs.

4. shaferfinancial - April 22, 2008

Thanks, bawld guy and Joe taxpayer. It took me much time and emotional work to get to the point of just accepting that I am not a good stock picker so I looked for the best out there and it wasn’t even close. Old Warren has proven his critics wrong decade after decade. I have moved most of my 401K/IRA money over to his capable hands and am richer for it in many ways! As for real estate, it is still the place where you can use that all important financial leverage to your advantage. What do you think is the proper loan to value for investment real estate as folks enter retirement and start to depend on the cash flow?

5. Driveby - September 29, 2009

Wow. And yet this post is still up, and with a link from your homepage. Astonishing.

I might just run the numbers on your whole portfolio in this post when I have a chance. I think it would be a most illuminating look at the “power” of leverage when a market sours. Berkshire Hathaway, for instance, is down “only” 30% from April 2008 at this point. Glad we mortgaged the house for that, Joe! (Worth pointing out–Warren Buffet, bless him, is 79 years old. Betting on the investment acument of Warren Buffet, Inc., is a long-term strategy?)

Dallas, though, I have to give you–it has weathered the real estate storm quite well so far. God help you if your investment property bought on margin goes down.

6. shaferfinancial - September 29, 2009


Is there anywhere in that post that says it was planned to succeed in 17 months? You can throw stones all you want, but I stand by the strategy for the long run. Income producing real estate is still producing income if it was bought at the right price [I have many posts on this issue] and not leveraged so much it was cash flow negative. Berkshire Hathaway’s cash flow has stood up fine and I would imagine the stock price will continue to improve as the each quarterly report demonstrates improvement. The EIUL doesn’t credit anything less than 0% so no loss of value there. And you even admit that Dallas real estate has held up well.

The real question how do you think Berkshire and the real estate will progress over the next 10 years.

I pretty sure Warren Buffett will get the last laugh with his investments. Look at how the Goldman deal has worked out. And even GE is getting withing striking distance of the warrants being in the money.

And PS, I would never take the post down, as it allows folks to see in real time my advice and that is something I do not hide from folks like the majority of the financial planning industry.

Add in the tax credits from the real estate [depreciation] and you are way ahead of the alternative. [you might want to calculate that as a comparison!]

7. Shaun - March 17, 2010

Mr. Shafer,
I agree with you (and threw in with 10k about 5 years ago) about Brk.b. Have question about the duplex – on another post I noticed you said the landlord business isn’t for you, buton this post you suggest people become landlords. I like the numbers and the idea of owning rental property, but can’t get over thinking what a headache it would be. Any thoughts?
I definitely need to simplify my portfolio and get things together in a comprehensive plan.

shaferfinancial - March 17, 2010

My friend, Jeff Brown, has turned me around about ownership of rental property. He suggests creating real estate investing plans too, which include professional management. The evidence is that the rate of return you get from investment real estate will out pace any other investment because of the leverage you are able to use. The downside risk is also shared with the lender. So I am fully on the side of ownership of rental properties and suggest it to my clients.

My best advice to you is to give Jeff a call: 619.889.7100
He knows more about investment real estate than I [by a long shot] and will give you the guidance needed to make that decision as well as advise you through the entire process. He loves to talk about real estate even if you don’t use his firm.

8. Sharon Tzib - August 7, 2013

Hey David! Great stuff on this blog. Question? You said, “Move their 401K money to a discount brokerage account.” You described Joe as having been at the same company for 15 years. Would he be allowed to do that? I thought with a company sponsored 401K you were forced to invest in the company offerings (usually under-performing, non-indexed mutual funds). Could you elaborate? Thanks!

shaferfinancial - August 8, 2013

You are correct for most. But some companies do allow you access to your funds. However, those companies are becoming fewer and fewer.
Another reason that I don’t like company 401Ks!

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