Pimp Your Finances

I read a thought-provoking article at CNN Money earlier today. It’s about a married couple – both 27 years old – who are aiming to be millionaires and retire by the time they’re 40. An admirable goal, to be sure.

But the weird thing is – they’re on track to do it.  How? They’re not using any secret formula or investing scheme. They’re just extremely frugal, and are passionate savers.

Their story

John Rodrigues is a manager at Microsoft. His wife, Gina, previously worked at Wells Fargo and Country Wide, but recently went into business for herself as the owner of a boutique. Together, they make an impressive $174,000 a year.

In the beginning…

They met as teenagers, when Gina was working in a computer store that John frequented. Their relationship started to get serious when they were in college.

John’s grandfather paid for his first year of school, but after that, he was on his own. This seems to have been a defining moment in John’s life.

Instead of racking up tens of thousands in student loans, he decided to get a job and practice frugality. As a result, he got his degree without going into debt.

Gina on the other hand, racked up $5000 in credit card debt before she came clean to John. They paid it off with the commission she made from selling her first house.

Life after college

After graduation, they bought a condo for $377,000 that quickly appreciated to $535,000. Emboldened, they decided to start investing in real estate, buying three houses in Arizona and Texas.

In addition to real estate, they put 15%-20% of their income into stock and cash investments. By the time they were 24, they had already saved $70,000 for retirement.

Where they are now

They have become experts in the art of frugality. They sold their condo for a pretty profit, and started renting a home from their parents for $650 a month.

They spend $300 a year on clothes, rarely travel, and only go out to eat three times a month (at the most). They use the extra money well. Half of their income goes to savings and retirement.

John aggressively buys discounted Microsoft stock, and the rest goes to his 401K and a variety stocks and cash investments. As of August last year, they had $380,000 in stocks, mutual funds, and cash (I’m guessing the portfolio is worth a lot less now)

Lessons learned

They’re doing a lot right, but are not perfect.

A few years ago, John went to a financial planner. Instead of good advice, he ended up getting locked into a pair of variable life insurance policies. They were ripoffs,  and he had to pay $5000 to get out of them.

They recently went to a pair of more reputable planners, and got some feedback about what they’re doing right and wrong.

Here are the opportunities for improvement:

• Dump the company stock. John currently has 37% of his portfolio in Microsoft stock, which is far too much to have in a single company. It’s even more dangerous, because his income is also tied to Microsoft’s success.
• Add some bonds. Right now, 99% of their investments are in stocks, and only 1% in fixed assets. The planners suggested 10% in bonds, 90% in stocks.
• Sell some real estate. They’re actually losing $750 a month on their three rental properties. The planners recommended selling one or two or their properties, which would stop the bleeding, and could allow them to break even on their initial investment.

What’s next?

John and Gina want to buy a home again. It’ll be expensive in the San Francisco area, but it’s a good time for it. Plus I’m sure they have the money for a down payment, and the credit to get a good loan. They’re looking to spend $350,000-$450,000.

They’re planning on being millionaires by the time they’re 40. If they can do that, they’re going to not only retire from their current jobs, but stop working altogether. Their long term plans are to move to somewhere less expensive – like Arizona – and start a small farm.

As for the financial planners’ advice? John isn’t buying it.

John insists on keeping the Microsoft stock, even though he’s putting most of his eggs in one basket.

Frankly, I think it’s dumb to sell low. I think it’s a safe investment to hold until the market comes up.

Their adviser’s response?

I don’t care what the stock price is. To diminish risk, you need more diversification in your portfolio.

As for the real estate? John doesn’t want to sell that either.

I think those properties are going to come back eventually. Even if they don’t, our retirement plan is not based on any return from those properties anyway.

Will they make it?

Their planners estimate that if they keep their current path, by age 40 they’ll have… drum roll please… $2.9 million. While that may sound like a lot, it isn’t, considering that they want to stop working at age 40.

Even if they draw from their retirement fund at 3% (instead of the standard 4%), they’ll run out of money at age 80.

My thoughts

I’m very impressed with how dedicated they are. It’s not easy to only eat out three times a month. It’s incredibly difficult to save half of your income.

However, for as dedicated as they are, they’re not always making the smartest decisions.

First, most of their portfolio and earning power is tied to the success of one company. Granted it’s Microsoft, but still, it’s dangerous to have your livelihood and retirement in one basket.

And I’m guessing John is incredibly intelligent, but could use some more work when it comes to his financial education.

He bought three properties – out of state – at the height of the bubble (partially because friends were doing it). Now he’s losing $9000 a year on properties, but refuses to sell, even though they’re not part of his financial plan.

He fell for the schemes of a shifty financial advisor, which I can sympathize with. But then he goes to advisers that he trusts, and refuses to listen to their advice.

Also, by retiring so early, he is giving up on the power of aggressive investing and compound interest. When they stop working, they’ll have to invest much more conservatively. Also, their portfolio will start losing money, instead of compounding every year.

Some people might criticize his frugal lifestyle, but I see it as an investment. However, by retiring so early, it seems like he’ll never really get to enjoy himself.

I don’t mind working hard and scrimping now, but it’s nice to know I won’t always have to. I like being able to do the things that are important to me – like travel. And I love knowing that someday, I’ll just get to enjoy myself and not have to think about money.

In the words of The Strokes:

I’m working so I won’t have to try so hard

- Someday