Caveat: this is still basically a draft, pending fixes and cleanup…
There is only one way I know of to build wealth fast when you are in your twenties. Many others will argue the best way to become a millionaire is to start a business. Here are the reasons why starting a business is not the most likely way you will become a millionaire.
- People start businesses because they are excited about the opportunity and their idea, and are motivated to succed in it. It means you need passion. If you start a business (e.g. new software) because you are only motivated by money, you will probably not have the passion to allow you to persevere and succeed.
- A new business is an over-time, all consuming job. You will have to give up whatever job you currently have and most likely any reliable salary in the early days.
- A new business may require specialized industry or technical knowledge or training you may not have. This limits you to business concepts tha you are equipped to execute on based on your background
- Risk of failure is common in starting a new business.
I could go on and on, but the bottom line is – if you are passionate about something and want to start a new business around that opportunity, then go for it. If you just want to find the most proven way to make your first million, read on.
To cut to the chase, the most proven way to build your first million is through home equity and real estate. By home equity, I mean buying properties you will reside in, instead of renting an apartment. Ideally, you will want to do this as soon as you can. When you get your first job, your mission should be to save for a down payment and establish your credit score. The two are equally important. If you cannot reach your goals for these two requirements, your first home purchase may not be a good investment.
- Down payment – you must focus on building this up as soon as possible. This must be your priority above all else. Do not buy a new car in your twenties (or ever). Do not buy the newest smartphone. Do not buy $50 tee shirts. Build out your down payment, and once you are in your very own first house years before your friends, they will understand why you carried around that piece of shit forever.
- Credit score – Your FICO score determines how expensive your monthly mortgage payments are. There are tons and tons of articles out there that explain what your FICO score is, and how to build it up. You want to get it as high as possible. This is not rocket science. There are many techniques you can use to increase your score. All of them require financial discipine and being a flawless borrower (credit cards, auto loans, student loans).
Once you are ready to buy a home, the next most important thing that will determine whether your investment pays off will be location and timing.
- Location – When bough my first home, I bought in a city that has one of the highest home price appreciation rates in the country. I know people who have bought their homes in cities or towns where home prices have not appreciated much in the past ten years. I’m a millionaire thanks to that price appreciation. My friends are not. It’s that simple. If you don’t live in a city or town with great growth in both job industries and real estate, you should move. If you live in a rapidly growing area, study the trends. There’s a good chance you may become a millionaire with your first one or two houses.
- Timing – I bought my first house during the housing boom of 2003. At the time, some people told me that prices have been going up so fast that it’s due for a drop imminently. Obviously those people were wrong. It actually crashed five years later. In 2008, I owned three houses. I sold one at the bottom of the market in 2011. I still made money, but I shoud have held on to it as it rebounded with a vengeance soon after. This is an important lesson of real estate: don’t buy or sell based on where you think the prices are going. Almost guaranteed that if you bought because prices were going up, it will go down soon. Also, if you sold because prices have been crashing, it will rebound just to piss you off. I also had friends back in 2007 who bought their dream house at the very peak of the housing bubble. When it all crashed a year later, they were underwater in their mortgage, had to sell for less than they owed the bank, and ended up renting for five years after that. You don’t want to be those people either, but I would still not base my buy or not buy decision on where I think the market is headed.
Lets talk about your first mortgage – on second thought, let’s not. This is a huge topic. Safe to say you want to go into this process with the highest FICO score and cleanest credit history as possible or risk paying way more per month than you could have. There are lots of choices to make, such as mortgage term (fixed vs. adjustable), mortgage length (30 year vs. 15), etc. You should familiarize yourself with the pros and cons of all those topics and maybe I will do a post in the future about them.
So you are ready to buy your first house. Now what? Single family house vs. duplex (or multiplex)
you may have saved enough money, done the monthly cashflow calculations (not covered here), and decided you’d rather have a duplex and rent out one side to pay for a good portion or all of your monthly mortgage. Not a bad idea, but it has pros and cons vs. buying a single family house.
- Single family houses have a lot more potential buyers (usually couples, families, etc.) , so they tend to appreciate at a higher rate than duplexes and multi-units. Multi-units are almost exclusively bought and sold by investors and they are priced using different criteria than simple market supply and demand.
- You can rent out the other unit of a duplex or multi-unit, and it may very well bring in enough monthly cash to offset your mortgage by a lot. This is advantageous over renting out rooms in a single family house. On the other hand, renting out two of three bedrooms in a single family house can more easily cover the entire mortgage, but you’d have roomates to deal with.
- Roomates vs. tenants – There are pros to having roomates as you can be more selective, they are usually more reliable with their responsibilities, and usually end up being good friends. Tenant relationships will always start and end as business relationships and less likely to be pleasant than roomate situations. Although there are always nightmare roomates so this is definitely YMMV.
- If you have saved enough money for a down payment on a duplex or multiplex, one possibility is to buy a second house as you will want to do this as soon as possible anyway. Two single family homes in my opinion are always better investments than multi-units for the same total price range. You can run your own numbers on the comparison and
Ok, you are now living in your very first house. You may have roomates, or maybe you bought a duplex and have a nice family living next door. Either way, below are some other things to consider
Property management – Lots of investors say you need to pay a property management company to manage your rentals. It’s a big job with lots of work required. However, for one or two houses, it is not a full time job. I’ve never used a property management company that did not disappoint me in some way, so I prefer to manage my rentals myself.
Maintenance and repair – I also do 75% of the maintenance and handy-man work myself. I’ve never considered myself a skilled contractor or handyman, but I’ve found that in hot markets, you can usually learn how to fix something on youtube and get it fixed faster than calling contractors, waiting for responses, meeting them, dealing with their work, etc. For something like a minor plumbing repair or replacing some rotted wood on a deck, you should absolutely learn to do it yourself if you can. If you are someone who is great at finding and managing contractors and vendors, you have a distinct operational advantage. One of the worst part of real estate investing is dealing with maintenance and repair.
Taxes – now that you own your own home and actually have tenants, you will love the tax breaks. This is a huge topic so I won’t go into details, but you have just opened up a world of tax deductions as a owner and landlord.
Leverage – Here is a key reason why owning real estate will help you become a millionaire as fast as possible – you are leveraging your investment returns with the money you borrowed from the bank. When you take your 10k and invest it into a mutual fund, your returns will always be a percentage of that 10k investment. So a 10% return will be gains of 1k. However, when you buy a house with a mortgage, and it appreciates 10%, you are getting 10% returns on a 100k house when you only put in 10k of your own money. So let’s say in the first year of home ownership, you gained 10k. You put in the same 10k you would have in the stock market. That is a 9k increase in your returns due to leverage. Even if we take away some of that because of the mortgage interest, you are still left with an amount you could not have otherwise made because you only had 10k to invest.
Mortgage vs. rent – Here is another key reason why owning your home is so important. If you aren’t paying a mortgage every month, you are probably paying rent. In many cases, the rent will be higher, and rent is not an investment. It never pays anything back. By buying a home, you are taking that money you’d otherwise pay anyway and investing it into your home which will be a fast appreciating asset.
Credit Building – Last but not least, having a mortgage tells the credit bureaus you’re basically a responsible adult now. Your credit score will grow much faster with a track record of timely mortgage payments. Another big topic on growing your credit, but this is a benefit you cannot get in any other way than getting a mortgage in your name.
In closing, this is pretty much the only way a young person with a job and saved money can get serious returns with minimal risk. Yes, you can forget all this and just rent an aparment and put every spare dollar into an Ark ETF, but I don’t think it’s the same risk to reward profile, and you’d still be paying rent. Let’s not forget short term capital gains taxes if you’re actively trading.
There’s a lot more to this topic so I may write a follow up soon, but what prompted me to write this is what is going on right now in our economy. We are in some strange times where the Federal Reserve and the US government are adopting policies that we’ve never seen before. In short, they are going “all in” on stimulating the economy. The byproduct is they are causing massive waves in all aspects of our economy where literally everything is going up in price – real estate, stocks, digital paintings, GI Joe dolls with missing heads, you name it. It’s freaking amazing if you already own real estate and stocks, but also scary. Who knows how this will end. Economists say they do not expect a housing price crash or severe inflation (ok, Jerome). But everyone sees the problem with deep artifical manipulation of how markets should work. While the intentions are noble (help people stay in their homes), who knows what the real consequences will be months or years from now.
I will just tell you one thing – if I was a young person right now, maybe a couple of years out of college, with some savings, and good fiscal discipline, I would absolutely try to find my first house before putting my savings in the stock market. Guess what, if you’re worried about a collapse in the housing market, what do you think will happen to stocks? Go back and look at 2008 for reference.
Common sense disclaimer: This post is just a journal. It is not intended to be read by anyone other than for the purposes of entertainment. I am not in the financial services industry, so I am not qualified to give any advice related to investing. Assume I am just your neighbor standing on the curb with you holding a can of beer and shooting the shit.