Warren Buffett is the third richest man in the world, a man who built his net worth by having a counter culture attitude toward investing and money. “I get greedy when others are fearful and fearful when others are greedy,” has been Buffett’s investment philosophy over the past 50 years, and it has worked out pretty well. Since fear has run rampant in both real estate and the stock markets, I have outlined two timely counter culture wealth-building strategies for high net-worth individuals (HNWI). Keep in mind that these strategies are designed for individuals who are in the highest federal tax bracket (35 percent) and have sizable savings and investment accounts.
Strategy #1: Keep the mortgage and invest in index funds.
Having a plan to pay off your mortgage and become debt-free is a great idea for each and every American; however, for HNWIs, it is wise to keep your home loan balance high during your peak earning years and build a separate account of stock index funds specifically earmarked to pay off the mortgage when you retire and possibly have a lower tax bracket. Since the total amount of mortgage interest paid is one of the few tax deductions available, HNWIs should keep a home mortgage during their peak earning years. Another real benefit of a stock dividend income compounding account is that it is taxed at only 15 percent. As long as an investor holds the index funds for one year, the long-term capital gains would also be taxed at only 15 percent for federal income taxes. An account in bank CDs or money market earns interest and may be less volatile, but it is taxable at 35 percent, which makes stock index investing a more tax-efficient way to compound your money. A monthly contribution, or dollar cost averaging strategy, into a diversified group of index funds (preferably Vanguard) would likely compound at an annual rate that is two to three percent higher than the mortgage interest paid over a 20-year period.
Strategy #2: Buy a second home or two.
Most financial advisors in today’s market are not likely to advise their clients to buy tangible real estate, especially a second home. Fortunately for me, I was raised by Realtors, and over the years I have learned some tax efficient strategies on how to build wealth and integrate real estate investing in a diversified retirement plan. The goal of this strategy is threefold: it will lower your current tax liability, improve your quality of life and afford future cash flow in retirement years. Since real estate in most parts of the U.S. is on sale and probably will remain that way through 2008, it’s a good time for high income earners to buy a second home. The key factor here is to identify an area that would be both a fun vacation destination and also have long-term capital appreciation potential. The
Big Island of Hawaii is an excellent example. Holding real estate for 15 years in this area would most likely produce extraordinary capital appreciation for two reasons. First, the Big Island is an international travel destination and, as our dollar continues to weaken; it will most likely attract larger numbers of foreign vacationers and investors. Second, there is only so much oceanfront property in Hawaii.
Strategy #2A: 1031 Exchange from capital appreciation to cash flow real estate.
The year prior to retirement is the year you should explore doing a 1031 Exchange from your second home to a commercial property. The prevailing concept behind the 1031 Exchange is that, since the taxpayer is merely exchanging one property for another property of “like-kind,” all gain is still locked up in the exchanged property, so no gain or loss is "recognized" for income
tax purposes. Most commercial real estate properties – depending on location – yield from five to nine percent in income. An excellent exit strategy is to wait until retirement, sell property with capital appreciation potential and exchange it into a high cash flow commercial property for your retirement years.
Counter Culture Mindset
Embracing these strategies might seem counter cultural, especially since the media likely will continue to inundate us with the noise of stock market recessions and real estate bubbles popping in 2008. Real estate over the last few years was purchased by those who couldn’t afford it, and over the next year or two, it will likely change ownership into the hands of people who can. We can learn from Warren Buffet, who believes that poor people tend to sell their assets to the rich at market bottoms because the average person lets fear negatively impact their investment decisions. If most of the current media “noise” is predominately fear and crisis, keep in mind that it also is a time of opportunity.
Ben Stewart is the President of Stewart Wealth Management Inc., a Marin County-based Registered Investment Advisory firm that specializes in financial solutions and money management for small business owners and high, net-worth families. He can be reached at ben@stewartwealthmgt.com; 415-464-4920, or visit his Web site at stewartwealthmgt.com.
