Erion Shehaj

https://youtu.be/nouSkGNRL5Y

When I posted a video on how to decide if you should pay off debt or invest earlier this week, a friend (and past client) commented with the following question:

What’s the best way to maximize the returns on investment for your stock market and 401(K) investments?

The answer may surprise you.

First let’s consider the following facts:

Over a 10 year investment timeframe 85% of mutual funds underperform the market. Extend the timeframe to 15 years and 92% of mutual funds underperform the market. In a nutshell, the overwhelming majority of funds underperform the market over the long run and charge you higher fees for that privilege.

But before you say: “You’re saying there’s still a chance …” you have the understand that the 8% that do outperform are not always the same funds. Meaning, a fund could outperform this year but underperform the next.

At this point I want to share one of my favorite quotes ever from Warren Buffett’s long time partner, Charlie Munger:

It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.

That idea is as profound as it is clever. Most “wounds” in the financial realm are self-inflicted. How else can you explain the fact that while the market averages 10% returns over a period of time, investors average 4%.

So what should you do instead? Focus on what you can control: Costs and not doing anything stupid!

The impact of costs on performance is incredible.

Let’s look at a scenario to illustrate it: If you invest $100k earning 6% interest for 25 years with no costs it will turn into $430k . Same scenario but with 2% annual costs and it only turns to $260k.

2% costs = 40% less principal

Let that sink it for a second. That 2% cost may not seem like much but it can devastate your portfolio’s performance. Or put a different way, your fund’s superior strategy would have to outperform the market by 40% just to offset the effects of its fees on your portfolio.

Simple Stupid-Free 3 step strategy to maximize returns in your stock market investments:

1. Invest in index funds and ETFs that mirror the market at the lowest possible costs.
2. Automate your investments
3. Leave them alone

401(K) accounts are a little trickier due to “pay to play” dynamics. That is, the fund has to pay in order to be part of the lineup of funds offered within the 401(K) plan of a corporation. Those fees paid are then passed on to the customer (you) through higher fees charged by the mutual fund.

However, many 401(k) plans have been adding low cost index funds and ETF because employees have been asking for them. So my advice on your 401(K) is to look at your current holdings as well as the other lower cost options within the lineup. Even if your 401(k) isn’t offering the lowest cost funds, you can still dramatically reduce costs and get an allocation that more closely mirrors the market.

“Cash flow vision” is a common blind spot among real estate investors who “worship at the altar of the cashflow” (as my good friend Jeff Brown would say).

It’s a tendency to ONLY pay attention at the cash flow produced by the property on an annual basis. For instance, an investor will run the Year 1 numbers on a rental property to calculate the cashflow for the year. Rent minus expenses minus mortgage payment equals cashflow. Then they divide the cashflow into the amount invested in the deal and calculate the cash on cash return. This return is then compared to an arbitrary return benchmark and a decision made.

Cash flow is nice, don’t get me wrong. But cash flow is not where the MAGIC happens in real estate.

The MAGIC is in the long game: Where you invest $37,000 into a rental property and net 3.3x that amount 10 years later.

The cashflow is the dividend you get every year and it makes you some money. But the growth over time is what makes you a fortune.

How do you decide between paying off debt vs investing in it real estate or the market?

A client asked me this exact question last week and I want to share with you the thought process I used to arrive at a good decision. The client has received an end of the year bonus at his job plus they had some additional money in savings. The sum was large enough where both investing and debt payoff were viable options.

The way this question is typically answered is by comparing the cost of the debt (interest rate) to the expected rate of return on the investment. If the rate is rerun on the investment is higher than the interest rate on the debt then you should invest. And vice versa. But is that really true?

Let’s say you have credit card debt at 16% interest. When you make the choice to pay off the credit card debt, your “rate of return” on that move is 16% (same as the interest rate) for as long as the debt would have been outstanding if you hadn’t paid it off.

Even more importantly, that rate of return on paying off debt is GUARANTEED. The moment you paid the debt off, you earned that return. On the other hand, the expected return on the investment is an estimate. An educated estimate if the analysis was done properly but an estimate nevertheless. So, it’s not correct to compare the returns in each move apples to apples. Instead, the expected rate of return on the investment should be adjusted down to account for the possibility that it won’t materialize.

Another benefit of paying off debt (in full) is that it frees up room in your income statement for you to save the payment you used to make toward investment capital in the future.

Not only that but it also frees up borrowing bandwidth for your future investments. Did you know that when you pay off a debt that has a $500 monthly payment, it adds roughly $80,000 to your borrowing capacity whenever you make your next investment purchase?

So, what was my advice to the client:

• Defer investing for a year
• Use your bonus to pay off some credit card debt and the remaining balance on one of the car notes
• AutoTransfer the payments to savings
• Purchase 2 properties next year