HOW TO SURVIVE MARKET DOWNTURNS WITH CONFIDENCE
Using Real Estate To Balance Your Portfolio
Do you ever wonder which direction the stock market is really heading?
Or if it is about to take a turn?
This week was like snow skiing on a black diamond run. But I had just learned how to get on and off the chair lift. Picture an out of control slide down the mountain, leaving one ski behind.
The Dow was down every day for six days in a row.
The NASDAQ is down over 11 percent since January 1.
Which end of the bull will you be looking at tomorrow?
I heard from one investor today that is faced with having to make RMDs, or required minimum distributions, from her IRA account. The value was set on January 1. Now she has to sell in a market where her shares are worth 10 percent less today than at the beginning of the year.
Some people are scared. Really scared.
Inflation is the highest that we have seen in decades.
The Federal Reserve made statements about raising interest rates. It anticipated seven increases over the next two years.
How long will it take for the stock market to recover?
Some people are scared that they will have to go back to work. That is not a good prospect for someone in their 70s. Or for many who are younger.
Most stock bear markets recover within four years. That means the market indexes returned to their previous highs.
What happens during four years of a bear market if you have to take RMDs from your IRA or 401(k)? You might have to sell some of your shares in a down market. And the dollar does not buy as much as it did four years ago.
So the market can recover 100 percent, and your buying power becomes less. How does that make you feel? How does it impact your long term spending plans?
How can you ride out a bear market with multiple streams of income?
For some people it doesn’t matter. They have created other streams of income.
HOW TO RIDE OUT THE STORM
To understand how to create multiple streams of income, let’s first take a look at some of the most common ones.
Social Security. This one is not available until you reach age 62. At age 62 you can elect to receive a reduced benefit, or wait and get full retirement benefits at age 67. It is indexed for “inflation”. I use quotes because the rate takes into account only certain items. But people know how much higher gas is now than one year ago, how much higher rent and house prices are, and how much groceries have gone up. All of those are more than the 6.9 percent increase that Social Security was increased on January 1.
Pension. This can be from a company or government. It may be either fixed or indexed for inflation. Fewer and fewer companies offer pensions today. Many offer 401(k) retirement accounts where the employer may match a portion of the employee’s contributions.
Stock Market. This includes stocks, bonds, and mutual funds, ETFs, or electronically traded funds. Some stocks pay a dividend, usually quarterly or annually. An income stream can be obtained from the dividends as they are paid out and by selling shares of stock which have appreciated in value. Most of the money in 401(k)s and IRAs is invested in the stock market.
Real Estate. Many types of real estate can be profitable. For simplicity we’ll look at two of the most common, single family homes and apartments. Both can provide a stream of cash flow. Both can be leveraged to obtain large chunks of cash and create favorable tax benefits. And both can be held in retirement accounts with certain custodians so that you can create cash flow prior to taking RMDs.
CREATING PASSIVE INCOME WITH REAL ESTATE
Single Family Homes. Buying and owning houses as rental properties is one of the most common ways of creating wealth and cash flow. The tenants essentially pay down the mortgage, and over time you can have a portfolio of rentals, free and clear of mortgages. Over time the rents go up with inflation, creating an even larger cash flow stream.
For some people this is too much work. Or they don’t want to be active landlords. That is okay. Hire a property manager.
Or be a private lender and act as the bank. A person can lend to an investor doing flips or as a bridge loan. Or provide long-term financing if rent is high enough.
Here’s something to consider. What is the bank paying for interest on CDs today? Do you know someone that would be interested in cutting out the middleman and lending directly to the investor?
One can also invest in multi-family real estate. Like apartments. Some of the benefits are economies of scale and less volatility from a vacancy. It is more efficient to manage properties in a central location. Consider the benefit of having a maintenance staff and not having to call outside vendors for every repair. What happens to your cash flow if someone moves out of a single family house? Compare this to a vacancy in a 50-unit apartment complex.
Investing in apartments can be easier than you might think. You can hire a property manager. You can be a passive investor.
Or you can be an active investor, general partner, or syndicator.
Apartment syndications are a common way for people to invest in real estate without having to be actively involved. One can invest in a multi-family apartment syndication partnership regulated by the SEC. The partnership may or may not pay a preferred dividend. Many create large chunks of equity that can be taken as cash when property is sold. Profits from a sale are typically taxed at a long-term capital gains tax rate, which is lower than ordinary income tax rates. These gains, if taken as large chunks of cash, can be used to avoid selling stocks in a down market.
All of the real estate options can be done with retirement accounts such as IRAs and 401(k)s. But not every retirement account custodian will allow it.
Social Security and pensions do not provide enough money for most people to enjoy the kind of lifestyle they dream about. Other streams of income are needed and must be accumulated. A stock portfolio is a primary component of many people’s nest eggs. But it is subject to high volatility. Real estate is a powerful alternative that can provide a stream of cash. It can also yield large chunks of cash or equity with tax benefits.
The right solution depends on an individual’s needs and how involved they want to be. I personally like a combination of properties that provide diverse streams of income. Some are properties in retirement accounts where I can choose to take distributions. These are managed by a property manager so that I do not need to have any day-to-day involvement. Others are leveraged with mortgages to provide greater long term gains. And, of course, I like participating in apartment syndications as a managing partner and investor.
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Mike is a retired aerospace engineer with a passion for real estate investing and teaching financial literacy. He lives with his wife in Daytona Beach, Florida.