The Power of Systems – Episode 084

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[00:00] I founded Ornot in 2013 and we made clothing for cyclists. For me, the best part of Shopify is the possibility of managing the business even without having technical knowledge. We managed to manage everything, from back-end to front-end and make online sales without complications. If Shopify were a cycling equipment, I would say it would be the bicycle itself. And that’s what allows us to get where we want. It is in Shopify that we manage our business. Start your free evaluation at Shopify.com Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your hosts, best-selling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel.

[00:45] Hey everybody, welcome to another edition of the Prosperity Podcast. No BS Money Guy, Todd Strobel with best-selling author, Kim Butler. And today we’re going to be talking about the power of systems. And I don’t know, sometimes when I think of systems, I think of diet. That doesn’t make me real happy. But we’re talking about setting up an autopilot way of generating wealth, aren’t we? Absolutely. And you know, systems are an interesting thing. They are the way that our bodies work. They’re the way our homes work. They are definitely the way businesses work or don’t work. Typically, if you have a problem, it’s a systems problem, not often anything else. And so when we look at our personal finances, we want to take advantage of that

[01:38] and really work some systems that can cause our wealth to be built on a fashion that becomes really a habit. If you think about the idea of a habit, that’s really what a system is. It’s something that once started happens over and over and over again. So I’m sure you’ve got some thoughts for us on systems. And then I have some examples of ways that we can get our money to be more systematic. Well, once again, I was at a seminar and I listened to a guy go through. He was in his 70s now and he talked about how he bought this house and he remodeled this house and then he sold it for a profit and then he took that profit and he bought two more houses He did this over a period of 30 years and he built up all of his money.

[02:29] And then finally, at the end, he sat down and he said, if I had it all to do over again, I would have just let my money work while other people did all the physical labor. I figured out that I was still building linear income because it was dependent upon what I could physically do. If I knew now how to make my dollars automatically do multiple jobs with the systems I now know, I could have spent that time creating memories with my family instead of hammering nails. Interesting. Well, and not that there’s anything bad in physical labor and or mental labor, if that’s your call, but it’s important to understand that we can get our dollars to do multiple jobs. So let’s just tackle some examples.

[03:24] One of my favorite ones is the real estate environment. And when you talk about investment real estate, so we’re not necessarily talking about people’s primary residences at this stage, but when you talk about investment real estate, you absolutely can get one dollar to do a bunch of jobs. So let’s walk through it. You’re going to first use a dollar of yours to get some dollars from the bank. So your dollar is going to be the down payment, but then you get other people’s money or the bank’s money or an investor’s dollar to come in and buy that piece of property. And so that immediately gets you leverage. And you can literally think about this like you would in physics, where you have a lever and that is a long stick

[04:11] that with that leverage enables you to move a big body. And that’s literally what’s going on when you’re buying real estate. You put in a little bit and with that little bit of money called a down payment, you get to control an entire building or an entire project or what have you. But then furthermore, now you have an asset and we could argue at what rate that asset is going to grow. But general rule of thumb says that real estate appreciates, over time, there may be some years when it doesn’t, but you have an appreciation capability that is there in the real estate. And then more importantly, you have something called cash flow. And our listeners know that flow or cash flow is one of our main principles of prosperity,

[04:59] but really good investments in real estate cash flow. In other words, more comes out of them every month to go into your pocket than what you put in every month in the form of mortgage payments and any of the other ancillary things that cause that building to run. So, where are we now? We’ve got three things going on, right? The building, the leverage and some cash flow. Correct. So, let’s take it a little bit further. With real estate, now you also have an opportunity for the disposition, whether you’re going to sell that, whether you’re going to use an exchange and trade up, whether you’re going to potentially give it away. Some people might do that in the form of a charitable remainder trust

[05:46] or what have you. You essentially have one dollar that’s done five, six or seven things just with this single transaction. And that’s true efficiency of wealth. And again, with real estate, it’s pretty easily laid out. And for some people, it’s easy to do. I think you have to pay a lot of close attention to what it is that you really enjoy doing. And if somebody really enjoys the physical labor and they enjoy the process of overhauling buildings or dealing with tenants or whatever, then that can be a really easy way to get one dollar to do five or six or seven jobs. But what do they do if they don’t enjoy that? Well, one practical piece of advice I think we’d like to give here is that there’s a lot of people who are tempted to do this

[06:36] inside of a self-directed IRA. And I believe it is, it’s certainly my opinion, I’m very hesitant about doing that because the other thing that we haven’t really talked about is the tax benefits, particularly if you’re holding this real estate for more than a year. I do believe each entity should be owned by either a corporation or a trust so that it’s not commingled with our personal assets. But we do lose a lot of those tax benefits by putting those inside of an IRA, don’t we? Yes, absolutely. So an LLC actually is probably the most common way to own real estate. And when you put real estate, whether it’s in an LLC or owned personally, inside an IRA, you give up all of the good taxation that the real estate property got,

[07:27] the capital gains tax, the depreciation, etc. And you lock it up in that box called IRA. And old school thinking used to say that IRA type tax law was beneficial. But most people today, I believe, think that tax rates are actually going to go up. And so deferring taxes, which is all that an IRA does, is not a good strategy if we’re truly in a rising tax bracket environment. So here you have this good real estate deal. If you stick it inside your IRA box, you have literally eliminated the ability to use a lot of the good tax breaks that real estate gives you. So yes, as a general rule of thumb, we are more proponents of people buying real estate with after-tax dollars and taking advantage of the good tax breaks that real estate causes naturally,

[08:20] rather than trying to use their self-directed IRA dollars to purchase that real estate. In addition, there is one tricky aspect of owning real estate inside an IRA that I would defer to the accountants to address. But it’s something that people need to be really careful about if they are going to do that. But let’s turn now and discuss how you could get $1 to do lots of jobs if you weren’t good at real estate or you didn’t have the time to have real estate be a part of your lives. Because a lot of people do have other jobs that they do enjoy doing. And though the idea of a real estate portfolio might be appealing in actual practicality, it isn’t going to happen while they’re in their current situation.

[09:06] So any questions you think we should address before we move on to a way that anybody can get $1 to do lots of jobs? No. And to me, this is the most important part because the part of real estate that attracts me the most is the purchase. So being able to find deals, being able to travel around the country and find multiple deals. And this is a way that you can do it inside an IRA and create that system would be to simply have a list of people that are looking for those properties that can be improved and flipped. For example, if you put $1,000 deposit down on a contract on a house that really was worth $250 or really was worth $275,000 and you simply sold that $1,000 contract, that $1,000 deposit,

[09:57] you took $5,000 and assigned that contract to somebody else. You’ve now made a whatever percent rate of return, $4,000 profit on a $1,000 investment. That would be good to be sheltered inside an IRA perhaps. Yeah. And yet I think the example that you went through while good for learning is going to be a challenge for people to actually act on if real estate isn’t their first love, if real estate isn’t their thing that they’re focused on. So I love the idea. It’s great thinking and that can absolutely work for somebody. Let’s switch gears and talk about how we can get $1 to do lots of jobs without real estate. And then I want to come back around and talk about how we can put these two specific things together

[10:45] and literally get $1 to do 12 or 14 or even 16 jobs. So the other piece that I wanted to cover is the life insurance and whole life insurance, just good old boring whole life insurance that’s been around forever and ever can actually enable $1 to do lots of jobs very similarly to real estate. In fact, I don’t think I’m aware of two more opposite products, real estate and life insurance that act more similarly. So let’s just run through the life insurance real quick. When you deposit a life insurance premium dollar, usually when you make that contribution or deposit, you call it a premium, you have an opportunity to get that dollar to do a couple things right off the bat. The first is that it builds cash value

[11:35] and an existing whole life insurance policy that you’ve had longer than one year is immediately taking your dollar and adding to it. So it might be $1.2 or $3. It might be $1.5. It might be $1.10. It might be even $3 or $4 of growth if you’ve had a policy for quite some time. But you immediately are building up cash value. That’s job number one. Job number two, of course, you’re immediately increasing death benefit. So $1 going in is probably going to raise the death benefit by $3 or $4. And then you’re immediately gathering a larger percentage of that mutual company. So mutual life insurance companies are owned by the people that own the policies and they pay a dividend every year by law that is the result of all of the profits

[12:24] of the company to their whole life policy holders. So obviously every time you add more to your cash value, you get the opportunity for more dividends from that company when it’s profitable, which most good insurance companies pay dividends every year for well over 100 years. So you’ve got some pretty confident aspects there of that dividend being paid. So we have three jobs right away and then there are a couple other potential ones. Just like real estate, you can use leverage. So cash value can be borrowed against. It can either be borrowed against at the insurance company or can be borrowed against at a bank. And then you also have some additional, very particular to the life insurance, riders, things like waiver of premium

[13:10] or long-term care coverage that are additional jobs that that dollar is doing. And then you also have that death benefit that’s increasing and that’s keeping pace with inflation. So I think without trying, we’ve covered another six or seven jobs just that the life insurance dollars can do all on their own, no special work done, just you making the habit of paying the premium and probably the pay to petition writer as well in an effort to grow your savings account. We don’t call life insurance an investment. It’s a savings or a liquid emergency opportunity fund. Place to store your cash. Yep, that’s the best saying in the world. The life insurance industry is the best place to store cash without a doubt,

[14:00] whether it’s for emergencies or opportunities. So many of us have already forgotten those 2008 years where we thought, wow, we had home equity. No, we didn’t. But we’ve got our home equity line of credit. No, we don’t. We can always sell our house. No, we can’t. But the mortgage payments are still due. They didn’t decrease with the value of my house. They still wanted the money every month. Absolutely. So let’s talk about combining the life insurance with maybe it is your own primary residence in a case like that or maybe it’s with investments. So one of the things that people are concerned about as it relates to their own home is potentially getting that mortgage paid off someday. And I think as a general rule of thumb,

[14:50] it’s not really the mortgage itself that bothers people so much. It’s the fact that they have to make payments. And as you indicated, that payment must occur on time, same amount every single month. So the larger emergency slash opportunity fund account you have, the more security you can provide your mind and your family as it relates to your mortgage payments. Because what’s really, really important is that that mortgage payment get made every single month. And what’s not as important is the value of the house in relationship to the mortgage or the value of the overall mortgage in relationship to anything else you’re doing. Yes, it’s a debt, but I would submit that it’s a good kind of debt to have.

[15:42] And something that we share quite a bit is there’s a big difference between being in debt and having debt. And if you own a home and you have a mortgage, typically and sometimes not true depending on what the market’s doing, the real estate market, but typically you’re going to be in a position of having debt. In other words, you have a half a million dollar home and a $400,000 mortgage. That’s having debt. Being in debt is where you have a $20,000 credit card bill, no job and no house. That’s being in debt and there’s a big difference. Would encourage a lot of people to read the book, The Millionaire Next Door. In the book, The Millionaire Next Door, they statistically gathered information about millionaires

[16:27] and pretty much all of them had mortgages, but yet the average millionaire next door not only has a mortgage, they have cash sufficient or assets, liquid assets, sufficient enough to pay all of their bills for 12 years, even if their income went to zero. So they would rather have the mortgage payment and the cash in the bank that they could pay for 12 years than the paid off house. And I would think a millionaire is a good person to use as an example. Yep, absolutely. And just think of the peace of mind that that would provide if you had 12 years of mortgage payments or 12 years of your expenses in an emergency slash opportunity account, but one that was earning a decent interest rate. And that’s what

[17:18] the whole life insurance does. In today’s world, 2016, you’ve got a four, four and a half percent net, net, net rate of return on that liquid cash that can then be used to make mortgage payments. So now let’s take this one step further and combine the idea behind $1 doing lots of jobs in a real estate deal and $1 doing lots of jobs in a life insurance cash value. And once you get past your emergency opportunity money, you can actually borrow against the life insurance cash value to go do more real estate. Now, if you don’t want to buy individual real estate properties, you can lend your money to individuals that are already in that habit. And so this is typically called a bridge loan or a hard money loan

[18:10] or sometimes even called mezzanine financing where it’s the ultimate of peer-to-peer lending. Not that that wouldn’t work as well like places like Prosper and Lending Club, but what we’re talking about is peer-to-peer lending that is secured by a first trust deed on an individual particular piece of real estate or sometimes this is done in a fund where a lot of different pieces of real estate are put together. So here you’ve got a situation where if you are funding a life insurance policy and you’re past your emergency slash opportunity account number, every family has a number that they want to have, 100 grand, whatever it is, all the other dollars could then be, if you wanted to, borrowed against

[18:55] and invested in a bridge loan environment which would then make monthly payments to you, which would then enable you to pay back the life insurance loan and do it again and again and again. And if you counted up all of the jobs that those dollars were doing, you would easily be at 10 or 12 jobs because of the combination of the work that’s being done between both the life insurance policy and all the jobs that it’s doing along with the real estate and all the jobs that it’s doing. And literally in this example, the life insurance would be making your real estate a better deal and the real estate would be making your life insurance a better deal. Super. Just a couple quick comments and then I know we got to wrap up.

[19:41] We’re starting to get some statistics back on the peer-to-peer lending. I think it’s a fantastic avenue. There’s a lot of work that needs to be done there. We’re starting to see some default rates of 60 to 70 percent in that avenue because, you know, you’re not risking a lot of money. I understand that. Same thing when you’re talking about bridge loans or you’re talking about hard money lending. This again, they’re not all the same. I would really encourage you to make sure you analyze the deals that are out there. We at Partners for Prosperity have looked at hundreds to find a couple that not only the underlying investment is guaranteeing the deal, but the company putting the deal together is guaranteeing it as well.

[20:30] So we’re seeing our clients get those checks in the mail every single month. So, you know, make sure you do your homework. Wouldn’t you agree with that, Kim? Absolutely. And find out all of the pros and cons. There’s always negative aspects of everything. And we’re very quick to share the negative aspects of both the life insurance, the bridge loans, as well as our other alternative investment that we like, the life settlements arena, because people need to know that up front. And then you can go forward with a good decision. And the other thing that we really like to do is start small. If you find a deal that you like, let’s see if you can get in at the minimum level so that you can get your confidence up

[21:12] and see the proof in the pudding, so to speak, before you put in larger dollars. Super. When we invite everybody to go to partners, the number for prosperity.com. And then if you also hit backslash ebook, we have an audio book there for you as well. This is the Prosperity Podcast. I’m No BS Money Guy, Todd Strobel. Once again, we’ve had our special guest and co-host, Kim Butler. Take care, everybody. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.