Badass Investor #1 – “CC”

CC, as she’s asked to be called, is a true badass investor. In many respects CC and her family are a typical American family – CC is 46 and her husband is 52. They have 2 kids – a 16-year-old and a 12-year-old.

But in other ways they are anything but typical – after just 23 years of work they have managed to build a net worth of approximately $4.3M. That’s success by just about anybody’s definition.

But what’s most interesting is the way CC and her husband have done it. They didn’t start a company. They aren’t doctors or lawyers or CEOs of large companies. Instead, they created their wealth the old-fashioned way – by getting an education, working hard, earning a high combined income, and saving/investing a significant portion of their wealth.

Their route to success has lessons for us all.

Lesson 1 – Education matters

We’ve all read about people like Mark Zuckerberg or Bill Gates who dropped out of college and are now billionaires. The reality, however, is that income tracks closely with education. How closely? The average college grad makes about 66% more money than the average high school grad.

The increased earning power provided by education is demonstrated pretty clearly by CC and her husband.

Both CC and her husband are highly educated. CC has 2 Masters degrees (an MBA in International Business and a Masters in Finance).  Her husband has a Masters degree in Computer Science.  As she told me, “So, with our educational backgrounds, it was easier to have great incomes from the very start.”

CC has been working for 22 years, the past 20 in the same company.  Her husband has been working for 23 years, moving to 6 different companies during that time. Here’s the history of their salary and net worth. (note: the salary numbers do NOT include their investment income or rental income. This is just earned income from their jobs).

Pretty impressive, isn’t it? Their income grew from a combined $104,381 in 1997 to a peak of $422,358 in 2011. That’s a 4.05x improvement in 14 years. That’s an average 10.5% annual increase.

Clearly, their investment in education has paid off.

And, despite CC’s already high educational attainment, she is considering investing in even more education to pursue becoming a CFP (Certified Financial Planner).

Side note: I’m also working on becoming a CFP – based on what I know of starting salaries for financial advisors it’s almost certain that CC would take a large decrease in salary, at least initially, if she were to switch careers. However, one good thing about being a Badass Investor is that CC and her husband have enough money saved to be able to make decisions to maximize happiness rather than to maximize income.

Related: Is a college degree worth the time and money?

Lesson 2 – You can’t overstate the importance of a high savings rate

Here’s some more background from CC:

From the very beginning, we’ve always attempted to save 100% of my income (it has always been the lesser of the 2 incomes).  In the early 2000s, we were both maxing our 401Ks and automatically investing another $5,000 per month (spread among 10 different mutual funds).  We built a pretty sizeable after-tax investment portfolio but we felt that we were not diversified enough (having 100% of our money in the stock market).  So, we pretty much cashed-out of our after-tax investment portfolio. The first thing we did was pay off the $300K remaining loan in our personal residence (it is a $600K home).  We also stopped putting in the $5K per month in mutual funds and focused our investing efforts in building a rental business portfolio.

There are a few interesting things here.

First, both CC and her husband were maxing out their 401(k) accounts. The 401k contribution limits ranged from $10,500 in 2000 to $14,000 in 2005. Let’s assume an average contribution limit of $12,000 for those years. Two people maxing out their 401(k) accounts means they were stashing a combined $24,000 in their tax-deferred savings accounts each year. PLUS, they were saving an additional $60,000 in taxable accounts. Saving $84,000/year is a great way to get wealthy fast.

Yes, I hear you. Of course it’s easy to get rich if you’re saving $84,000/year. But what about people who don’t even make $84,000/year?

Look at CC and her husband’s salaries in the table above. From 2000 to 2005 their combined salary averaged $210,591. If they were saving $84,000/year that means they were saving an average of 39.9% of their GROSS salary.

If we assume they were paying an average of 25% in taxes, that means they were saving around 53% of their after-tax income.

Regardless of how much money you make, saving 53% of your paycheck is a surefire way to financial independence. After all, it’s hard to NOT get rich if you’re saving over half your income.

Lesson 3 – Have a plan for your investments

CC and her husband started building their wealth by investing the stock market. However, after her husband lost his job in 2002 they sat down and realized they needed a more diverse (and possibly lower risk) portfolio. They decided to move heavily into real estate. The property portfolio they’ve put together in the last 11 years is impressive.

From CC:

Here’s the timeline of how we built our rental business portfolio:

Rental #1:  Year 2006, Condo purchased for $150K all in cash

Rental #2:  Year 2006, Condo purchased for $300K ($200K cash, $100K financed, 10 year note)

Rental #3:  Year 2007, Condo purchased for $60K all in cash

Rental #4:  Year 2008, Townhouse purchased for $120K all in cash

Rental #5:  Year 2009, Single-family home purchased for $145K ($45K cash, $100K financed, 30 year note)

Rental #6:  Year 2010, Single-family home purchased for $150K ($50K cash, $100K financed. 30 year note)

Rental #7:  Year 2010, Single-family home purchased for $155K ($55K cash, $100K financed, 30 year note)

Rental #8:  Year 2011, Single-family home purchased for $161K ($41K cash, $120K financed, 15 year note)

Rental #9:  Year 2013, Single-family home purchased for $200K ($80K cash, $120K financed, 15 year note)

Rental #10: Year 2015, Single-family home purchased for $320K ($100K cash, $220K financed, 10 year note)

Since we bought our rentals, the values on some of them have completely doubled.  The houses we bought between 2009 and 2013 are now up between 60% to 100%.  Property values in our area have skyrocketed since the Great Recession.  Much of that can be attributed to a huge influx of transplants from other states given the robust job market here.  These new residents have been bidding up home values during the last several years. Our city has net gained about 700,000 new residents in the last five years alone.  The total value of our rental homes are now about $2.1M.  Including our primary residence, we have about $2.7M in real estate.  We have another $300K in other assets.

One of the first things that struck me was that 3 of their first 4 investments were bought with cash. From 2006 to 2008 they used $530k in cash to make real estate investments. They had a plan (to invest in real estate) and they executed aggressively on that plan.

Another thing that sticks out – they continued to buy real estate during the downturn from 2009-2011. This was a tough time to purchase real estate – banks didn’t want to lend money and it was tough to get approved for loans. Plus, there’s the psychological barrier of buying an asset that’s melting down. Every time you turned on the TV or opened a newspaper from 2009-2010 you’d read about mass foreclosures, plummeting real estate values, etc. It was a very scary time to buy real estate.

It was clearly also a very profitable time to purchase real estate – as CC  mentioned, real estate values have skyrocketed and some of these properties have doubled in that time. By putting aside their fears and continuing to invest in the tough times CC and her husband have realized significant gains in their investments.

For fun, I went ahead and calculated the IRR (internal rate of return) on the value of their properties. Note that this ONLY considers the actual value of the properties, it does NOT include any of their rental income from the properties:

A few notes – the “Internal rate of return on total property value” is the return on the purchase price of the house. So if a house was bought for $100,000 and the next year was sold for $120,000, the total gain on the house was $20,000 and the IRR 20%. If a house was bought for $100,000 and 2 years later was sold for $120,000 the total gain was still $20,000, but the IRR would be 9.54% because the $20,000 gain took place over 2 years.

The “Internal rate of return on invested cash” is the return on the amount that CC and her husband actually invested. Using the example above, if they bought a $100,000 house for 20% down and sold it a year later for $120,000, the gain is $20,000. However, since they only invested $20,000 and ended up with a $20,000 gain, their IRR was 100% (that’s the beauty of leverage).

So, looking at the table above, we see the total IRR for just the values of their property is an underwhelming 2.5%/year. However, if we look at the IRR on their investment we see that they earned a very respectable IRR of 10.4%. And again, that’s JUST the property values and doesn’t include the rent (which was likely in the range of 5-10%/year).

CC and her husband put together a plan to diversify away from the stock market and into real estate and they were clearly very successful in doing so.

Lesson 4 – The road to becoming wealthy has a lot of twists and turns

We tend to think of creating wealth in terms of straight lines. You save $10,000/year, you invest it at an average 8% return, and in 30 years you have $1,132,832. Each year you’re wealthier than you were in the previous year.

But the real world rarely works that way. Our income fluctuates. The stock market crashes and recovers. We have periods of unemployment (voluntary or otherwise). Some investments pan out, others fail.

The hope is that on average and over time our net worth grows each year, but in any given year our net worth could move up or down. CC and her husband certainly weren’t immune to this. In the late 1990’s they enjoyed a surging stock market and watched their net worth rocket from $350k in 1997 to $1M in 2000. Then, as the market crashed in the early 2000’s so did their net worth, and by 2002 their net worth had dropped 46.7% to $533k. It wasn’t until 2005 that their net worth was back over the $1M mark.

In addition to ups and downs of the market they had another money setback in 2002. From CC:

We had a big money lesson in 2002 when my executive husband lost his job via corporate politics.  He was a rising star in that start-up (he was the COO) and was laid off in a moment’s notice.  From then on, we were vigilant about our money and investments and wanted to take on as little risk as possible.  That’s the reason we are very aggressive in paying down debt.

CC and her husband had an unexpected job loss early in their career (and during a very tough job market in the tech industry in 2002). And, in a case of Murphy’s Law, the job loss came when their net worth had bottomed out due to stock market losses.

Not only did CC and her husband recover, but they learned an important lesson about their appetite for risk. This rollercoaster is, in part what lead them to diversify away from the stock market and into real estate. Of course, they did so just before the real estate market crashed from 2009-2010, but CC and her husband didn’t panic. They continued to make new real estate investments throughout the crash and the value of some of those investments has already doubled.

Lesson 5 – You only have to get rich once

Using high-risk investment options when you’re young or broke is a defensible strategy. I don’t think it’s the optimal strategy, but I can understand the logic behind an 18-year-old kid buying internet stocks on margin or otherwise swinging for the fences. The kid is young and broke. Earning a 10% annual return on nothing isn’t going to generate wealth very quickly. There’s an allure to high-risk, high-reward investments when you have nothing to lose.

But once you’ve achieved a level of wealth that provides the standard of living you want, additional wealth isn’t going to improve your life but losing your wealth will certainly hurt your life. Rather than optimize your investments for higher return it makes sense to optimize for lower risk.

More from CC:

These days, after we max out our 401Ks ($24K for him and $18K for me), we are just aggressively paying down our remaining mortgage loan balances.  We have prepaid fairly quickly 2 of our initial 7 mortgages (mortgage #2 for $100K and mortgage #5 for $100K).  We now carry only 5 mortgages with current outstanding balance of about $630K and total payments of about $4400 per month (about $2200 of the monthly mortgage payments go towards principle).

We feel that as long as we have debt, we’re not completely free from our corporate jobs.  If we were both to lose our jobs, we didn’t want the burden of having huge debt payments.  I know that we can possibly have better return on our money investing it in the stock market, but the peace of mind of having many of our properties mortgage-free is priceless.

CC understands that you only need to get rich once.

Incidentally, Warren Buffett had some interesting comments on high risk strategies for people who are already wealthy. In 2007 he gave a talk to some MBA students at the University of Florida. He was talking about Long-Term Capital Management (LTCM) blowing up in 1998. For those who aren’t familiar with LTCM, it was run by very smart (including 2 Nobel prize winners in Economics) and very rich people who managed to bankrupt themselves by using massive leverage. To give you an idea of just how much leverage they were using, let’s look at a regular mortgage. If you put 20% down and finance the remaining 80% you’re leveraged 4-1 (80% debt to 20% equity). LTCM was using 25-1 leverage!

I thought this quote from Warren Buffet regarding LTCM was awfully insightful:

…But to make money they didn’t have and didn’t need, they risked what they did have and did need, and that’s foolish. That is just plain foolish. Doesn’t make any difference what your IQ is. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.

I think this is where a lot of people get tripped up. Once you have enough it doesn’t make sense to risk what you have for what you don’t need. Of course, “enough” is very subjective and it the topic of much debate in the blogosphere, but everybody has a number that they consider “enough”.

CC and her husband understand that. They are reducing risk by aggressively paying down their existing debt. At this point, reducing their risk is much more important than trying to make more money.

Related: In the late stages of a bull market you should be reducing leverage
Related: Your debt is literally killing you

Lesson 6 – You don’t need to track every penny you spend

In my experience, very few wealthy people track every penny of money they spend. I do believe that most wealthy people have a general budget, but that’s it. Yes, this flies in the face of much of what’s practiced (and preached) in the personal finance community, but the reality is that precise tracking of spending takes time and mental energy that’s probably better used to increase income.

From CC:

Our level of personal spending is around $200K per year.  Since we don’t have a mortgage, that amount is spent mostly on the kids, vacations, and shopping indulgences.  We spend about $50K yearly on the kids for private school and multiple activities (both kids are in hockey, soccer, piano, and academic enrichment classes).

We spend another $40K per year on vacations.  Property tax, utilities, and insurance make up another $25K, Groceries of about $12K per year, Eating out of $12K per year, Home improvement of about $20K per year (our home is about 16 years old so we’re doing a lot of upgrading), Shopping of about $20K per year, Charity of about $10K per year,  and other miscellaneous spending.  We don’t necessarily budget our spending.  What we target is the level of savings.  As long as we’re saving the $200K per year, we feel free to spend the other $200K as we like.

I know that $40K per year on travel seems excessive, but we’re huge believers in experiencing life.  We take our kids on multiple family vacations per year.  We average about 5-6 trips per year.

Some people will look at these expenses and criticize spending $50k/year on private school or $40k/year on vacations. But CC and her husband have reached a level of financial security that they can afford to spend this much money and still hit their saving goals.

As CC says – “What we target is the level of savings”. Rather than worrying about pinching every penny, they have established a savings goal. Once they hit that savings goal they are free to spend the rest of the money. And they spend money on things they believe enriches the lives of their family, including extensive travel.

As a result, CC and her husband don’t feel that they are depriving themselves or their family in their quest for financial independence.

Lesson 7 – Have a plan

Even though CC and her husband are already rich, they still have a detailed plan for the future.

Our Gross Income is about $550K per year, made up of W2 income of $400K and rental income of $150K per year.  Our net savings is around $200K per year.  We are planning to retire in 6 years, when I will be 53 and my husband will be 58 years old.

$150,000/year in rental income! The plan that CC and her husband put together to build a sizable real estate portfolio has clearly paid off.

 In the next 6 years, we plan to deploy about $1.2M of total savings ($200K yearly savings over 6 years) by doing as follows:

1)  Pay-off remaining mortgages of $630K

2)  Max out 529 contribution of $28K for our younger child over the next 5 years.  That would be $140K (he goes to college after 6 years).

3)  Max out 529 contribution of $28K for our older son over the next 2 years.  That would be $56K (he goes to college after 2 years)

4)  The rest will be deployed either in our 401Ks or taxable accounts

Even though CC and her husband have a net worth of $4.3M they are still aggressively saving. They have a clear plan – pay off their mortgage, pay for their kid’s college, and save the rest.

Although I’ve largely focused on their real estate holdings, CC and her husband have a nicely diversified portfolio of investments.

At this time, our investment accounts are made up of the following:

My husband’s retirement account of about $900K

My retirement account of about $800K

Taxable portfolio of about $200K

College 529s of about $100K

Retirement accounts are spread between Rollover IRAs, Roth IRAs, and 401Ks.  The IRAs are about 50% in stocks and 50% in ETFs and mutual funds.  The 401Ks are 100% in mutual funds.

THAT is the sort of plan I’d expect from a badass investor. They’ve projected their savings. They’ve decided what’s important to them (paying down debt) and they have a timeframe by which their debts will be paid.

Given the above, we can make some pretty reasonable projections about the level of net worth CC and her husband will have at retirement. Their current net worth is $4.3M. If we assume a very conservative 5% return then in 6 years it should be around $5.76M. We then add their $1.2M in savings (assuming it’s used for debt reduction and the debt reduction results in no additional savings) and have a final net worth of $6.96M. Not too shabby.

Conclusion

Although their numbers are large, the principles behind how CC and her husband got rich apply to everybody. They didn’t start their own business or win the lottery. They haven’t had a million dollar stock option payout. Instead, they invested in themselves by pursuing an education in lucrative fields. They saved a large portion of their income and they had a plan for how to invest their money. Now that they are close to retirement they are reducing risk rather than continuing to try to make more and more money.

Let me know if you’ve found this profile interesting. Are there any lessons you’ve learned from this profile? Would you (or somebody you know) like to be profiled in this series?