Minimal risk, big reward.

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I was chatting with a close friend a few days ago about the housing market. Big surprise right? We know what the median household income is in Seattle ($66,000), and we also know the median sales price of a home in Seattle right now is $380,000. What we don’t know is how the crap people can afford a $380,000 mortgage on a $66,000 annual income! There are only a few logical conclusions…

1. They inherited the property

2. They received a financial windfall

3. They are house poor. 

4. They are risk takers.

If they inherited the property, or received a financial windfall, good for them.

If they are house poor, I can’t say I’m jealous of them. Nothing about living paycheck to paycheck appeals to me. I would never want to be in a position where I have to sacrifice traveling, eating out, or skiing just so I can make a mortgage payment. No thank you.

But what about the people who are just willing to take a risk?

Debt has a pretty bad rap. Heck, I even named my blog Punch Debt In The Face because I think it’s so dumb. But reality is, debt can be a powerful tool for building wealth; like when one takes out a line of credit to start a business, or when someone finances a rental property.

Sure it’s risky. If the business fails, or the real estate market crumbles, you could lose everything. But how bad is that really? It’s not like you have to worry about going to jail. Maybe you get sent to collections and settle your debt for less than you owe, maybe you walk away from your house and get foreclosed on. Maybe you have to consider filing bankruptcy. While none of these things are particularly enjoyable, they are solutions.

Maybe I’m too conservative for my own good?

I mean, if we bought a $500,000 house in 2012 we’d have about 15% equity in the thing based on recent market appreciation. That’s a $75,000 gain in less than two years!!!

What did I do?

Oh that’s right. I decided to keep saving money so we could easily afford a 20% down payment on a house priced $150,000 under what we were qualified to borrow. At last check, my savings account earned a paltry 0.75%. 

Do you see what I’m saying friends? It seems to me that the risk/reward comparison of using debt to leverage one’s financial position often favors reward. Think about it.

We buy a $500,000 house and sell it a year later for a $50,000 profit (after commissions). Or we buy a $500,000 house, watch the markets tank, and walk away from the property and let the bank deal with it (Washington is a non-recourse state). The system is set up to protect one against their own stupid decisions, so much so, that these stupid decisions are no longer necessarily stupid.

Interest rates are low, and house prices are still lower than pre-bubble days. Why not use the depressed market, and government bailouts (quantitative easing), as an opportunity to make some extra dough?

Oh that’s right, because I’m a wuss.

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Being conservative might not make me rich, but I guess it beats the possibility of being poor?

13 thoughts on “Minimal risk, big reward.

  1. I am pretty risk averse too and yes I may have passed up on many “good opportunities” but, to me sleeping comfortably is priceless. It is a personal thing I guess and there is no right or wrong about it. I don’t care being a wuss…

  2. I don’t call it being a wuss. I call it being honorable…don’t borrow what you can’t afford! Good for you for being honorable.

  3. I’d be interested in an update post on what you ended up doing with paternity/sick/vacation days upon becoming a dad. I hope that’s coming in the future!

  4. I’m probably the biggest wuss there is. About 25% of our net worth is in our house and about 70% in savings accounts. The remaining 5% is probably in our cars and my tiny 401k I just started this year. Even my Roth IRA is stuck in a money market account because I’m still paralyzed with fear about picking a stock, mutual fund, or ETF. I’m actually kicking myself because I did get a stock tip in regards to Twitter a few days ago and it jumped 30% today!

    However, even though I’m a coward in regards to investing, our “emergency fund” is about 10 years worth 😛

    • I know it feels safe seeing your account balance not change day to day in a savings account. It probably makes you feel as if you are building wealth slowly and safely but in reality you are loosing money every day. All that money in a savings account is loosing its value to inflation. This method is actually the riskiest investment you can make because you are almost always guaranteed to loose money. In comparison to a well diversified portfolio of investments that may loose money in the short run, and yes it may be steeper losses than you see with inflation, but stands a great chance of gaining value and building wealth in the long run. Even if your investments earned enough to just kept up with inflation you would still be in a better position than you are now.

      If I was you, I would not keep more than a year of expenses in an emergency fund and invest the rest across many different asset classes including stocks, bonds real estate. A good website to check out is http://www.betterment.com. Or if you like the researching investments, which most people do not, then I would go to vanguard.com. Again, your current investment strategy is the riskiest there is, unless you consider a car an investment. Hope this helps 🙂

      • It must be nice to never have lost money investing. I’ve lost enough money to be forever traumatized. I still see the markets as a Ponzi scheme and don’t want to be the one holding the bag after all the baby boomers yank out their money in the coming years. I’ll live with my losses in regards to inflation.

        Although I did start up a 401k just recently but mainly for the tax deferment than a real whole hearted investment in the stock market…

  5. I am also somewhat risk averse and it has cost us many many thousands in real estate gains but we bought what we could afford instead of speculating! Another reason people can afford homes in that price range is they may have made or are making money on their first home. Say they buy a condo or house for $175,000 five or ten years ago, now selling for $250,000, they can just put the profit on the house they’re moving up to plus any equity they’ve built up.

  6. This is how I made my money. To be honest, I feel I was lucky. I wasn’t a plodder, but when it came to real estate, I took chances. A few deals and I pretty much got set for life.

    My feeling is to take bigger chances when young. You have less to lose, and the upside can be so much more than the downside. In fact, even if you fail, in a weird way, you still win. (You’ll have to do it to see what I mean.)

    So I bought property in a shitty part of town and if I had to do over again, that’s how I’d do it. It was scary being that I came from a middle class background, but everything worked out better than I ever dreamed.

    Don’t worry so much about taking on a lot of debt. Instead by a piece of crap home and fix it up. Rent out the rooms.

  7. So this is how I was raised. My dad working earning maybe $60000.00 a tear, mom stays home with the two kids and the mortgage is $300+. As a banker I see it all the times. It’s one of the reasons I want to get out of banking, I’m enabling people to make poor decisions and it’s so wrong. But I didn’t really think I about how sad the numbers actually are. Makes me very glad I’ve stuck to renting.

  8. Say you bought a house for 500k, and you can now sell for 550k- That’s a 50k profit(actually, less after agent commissions). It also means that you’ll no longer be able to buy the same, or similar, home for 500k in that same area. You’ll need to give up the 50k, in order to buy a similar home for 550K.
    It’s a wash, unless it’s a rental property we’re talking about.

  9. I don’t particularly like risk, either. It’s not worth the stress to me. I’d much rather earn a profit at a slow, but steady rate rather that have the risk of losing a large chunk of my hard earned money. Someday when I’m not swimming in debt, my viewpoint could change.

  10. There’s a flaw in statistics there… Most of the lower income earners are most likely not buying houses. Therefore the median income of HOMEBUYERS should be the number used for comparison. 1% hold the majority of wealth right? Those in the top income brackets probably own a few properties, while those in the bottom income brackets probably don’t own any. Thus, the median house value is able to outstrip the median income… Sad but true, there are many people simply priced out of the market in major cities all around the world. The rich can afford the risk and continue to gain wealth in most cases with capital gains etc.

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