401(k) vs. Rental Properties

I’ll start off with a meaty discussion of one of my most difficult current decisions: do I allocate savings to my 401(k) or to saving up for my next rental property?

Backstory

It probably makes sense for me to set the stage by giving you a more detailed backstory.  So, without further ado…I’ll tell my story by summarizing a few critical high points:

1) I graduated from a decent university with a degree in finance, a solid GPA, and no debt.

I grew up in a lower-middle class midwestern family, the son of two parents that worked their butts off for my two siblings and me.  They not only worked very hard day in, day out at tough day jobs to put food on the table, but they also earned enough side income from various small entrepreneurial ventures to pay for my (an my siblings’) college education at a decent four-year college.

2) I got a job out of school at a large accounting/consulting firm.  

I didn’t make a ton of money during my first few years out of school (think ~$50k salary range), but I was pretty frugal and made enough to start dabbling with investing.  I didn’t like my job at all, and I was pretty familiar with the concepts of compound interest and passive income from my undergraduate finance education.  At that time I didn’t really geek out about personal finance, but I diligently saved as much as I could and invested in stocks.  I did this in a post-tax brokerage account and didn’t really concern myself with my 401(k), thinking that I’d prefer to sacrifice the company match in order to start building up a passive income stream.

3) I got married and got a new job. 

After being out of school for a few years, I strong-armed the PFL (Personal Finance Lady) into marrying me.  I also got a new job at a smaller firm making a little bit more money (think ~$80k salary range).  The PFL worked as well, and we collectively brought home around $110k/year for a couple years.  We lived pretty frugally and saved money during our first year of marriage.

4) We bought a house and became more interested in personal finance.

Originally, I didn’t intend to buy a house until some time in my 30s as I viewed a home as more of a liability than an asset.  However, after going through the disappointing process of unsuccessfully looking for a decent rental in our ideal neighborhood at a reasonable price – and then running the math to realize that it would be much cheaper in the near-term to own than rent – we decided to buy a place.  We had enough liquid assets to put down a 20% down payment on a small but decent starter 3br/1.5 bath house.  In many midwestern cities, ours included, you can certainly find a decent starter place for $100k, which is what we paid for ours.  As of the date of this writing, we still live in that house.

It was also around this time that I started getting really into personal finance, and I began tracking our net worth on a monthly basis.  Real estate got me thinking more broadly about my investing priorities and an asset allocation scheme, as up to that point I had primarily just been investing in dividend-paying stocks.  Somewhere in there I started realizing the value of contributing to my 401(k) – at least up to the company match so as not to forgo free money.

5) I started buying cash flowing real estate, and leveraged up to do it.

Over time, I grew partially frustrated with the volatility of the stock market.  It didn’t make sense to me that the fundamental value of a company could swing back and forth violently from day to day, and so I began looking for alternative investments with less volatility and seemingly more control.  That’s when I started taking a closer look at cash flowing real estate as an asset class, and slowly started purchasing rental properties in my greater metropolitan area, as resources allowed.  I started buying properties in relatively low income neighborhoods where the yields were strong, and I outsourced 100% of the property management.  Basically, I was just taking ownership of assets that were performing well to begin with, and utilizing both traditional bank financing and private loans to do it.

6) I started a side hustle.

My side gig is kind of hard to explain, but I’m a co-founder and partner of a small but growing business that produces some cash flow.  In terms of actual market value (based on the valuation at recent buy-ins of additional partners), my stock in this company is >50% of my net worth, but I basically hold it at cost for net worth reporting purposes.  I’d love to get thoughts from the community on how you view private stock with respect to net worth.  My take is that until it’s liquid or at least realizable, holding it at its cost basis probably makes the most sense.  Anyway, this is a decent part of my financial picture, although I’m guessing I won’t talk about it too much on the blog.

7) Where we are today: I had a kid, became more conservative, and started making more money.  Also, I like going to work every day.

My wife and I had our first child in 2014, which gave me a greater desire to have a more balanced financial picture.  I started allocating some funds to a 529 plan (college savings vehicle) and wanted to have a beefier-than-before cash position to compensate for the risk in my portfolio with so much real estate and debt.  Still working on building up those cash reserves.  My wife moved to part-time work for a while, and eventually quit working altogether to stay home with the baby.  My career started making strides in the right direction (think ~$130k salary range – not where I’d like it to be, but that goes a long way in the midwest) and I really started enjoying the work I do.  Around this time I basically concluded that I think I’ll always want to work, at least for the foreseeable future.  The most immediate practical ramification of enjoying my work is that I’ve started lessening the focus on passive income and shifting my mindset to general wealth creation, which has meant more of an interest in tax efficiency, long-term passive indexing, entrepreneurship, etc.

Welp, that about does it for a summary of my backstory.  I left out lots of details, but this should provide a decent backdrop for us to move forward.  I’d love to hear your thoughts and answer any questions you have!  Best,

PFG