First, I would like to thank everyone for their interest in
the first part of this article - "The Fast Track to Your
Financial Freedom (Part 1) - Leveraging your Money".
Now, you may now be thinking that this whole idea of
leverage is great and earning $81,000 on a $20,000
investment over seven years would be terrific. The problem
with this is "IT'S STILL TOO SLOW." We can still do much
better. Besides leverage, we need to add the principle of
VELOCITY. Here's how it works:
In the first year, the investor takes the $20,000 and buys
the same $200,000 home as previously illustrated in The
Fast Track to Financial Freedom (Part 1) - Leveraging your
Money. The home still appreciates at 5% each year and the
rents on the home cover the expenses of owning the homes,
including the mortgage payment.
After two years, this home will be worth approximately
$220,000. Instead of letting that appreciation sit and
accumulate, the investor borrows it out and buys another
$200,000 home. How is this possible? Quite simply, the
investor puts a second mortgage on the home in an amount
equal to the appreciation. The rent is raised just enough
to cover the interest on this additional loan. (Most
landlords raise the rent at least every two years.)
The second home also is rented out and appreciates at 5%
per year. Every two years, the appreciation for each home
the investor owns is borrowed out and used to buy new homes.
By doing this, at the end of seven years the investor will
own eight homes with a total value of $2,020,000 and equity
of $273,000. This is compared to equity of only $101,000
if the investor only bought the first home and compared to
equity of $39,000 if the investor had relied on the
compound interest from mutual funds. This is what we call
VELOCITY. Velocity of money is simply the process of
continually moving money into new and better investments.
At a net equity of $273,000 the investor has more than
thirteen times their original investment in seven years.
This is so much better than compound interest that most
people have a difficult time believing it.
When I do this demonstration in a seminar, there is always
at least one person who will not believe it is possible.
At that point, I ask the audience if anyone has ever put
the concepts of leverage and velocity into practice.
Invariably, someone raises their hand and explains that in
actual practice, it has worked much faster than what I have
demonstrated, because of the very conservative nature of
this demonstration.
You probably would be thrilled with this level of returns.
Our clients at ProVision would be disappointed in a value
of ONLY $2 million at the end of seven years from a $20,000
investment. Why? Because, this return does not factor in
any of the tax benefits from investing. Tax benefits, when
properly taken, CAN DOUBLE YOUR INVESTMENT. Here's how.
Let's go back to our example. Suppose our investor is in a
combined federal and state tax bracket of 35%. Suppose
also that our investor has excellent tax advisors, like
those at ProVision, who understand the MAGIC OF
DEPRECIATION.
Depreciation, quite simply, is a non-cash deduction each
year for a portion of the purchase price of the rental real
estate. This deduction will put a considerable amount of
money back into the pocket of the investor.
Suppose that the investor takes the tax savings from the
depreciation and uses it to purchase additional
single-family homes. And just like the other homes, every
two years, the investor borrows out the appreciation and
buys another homes. At 10% down and 5% annual
appreciation, with just the original $20,000 investment and
the tax savings from depreciation, at the end of seven
years, the investor will own the following:
- 16 homes with a total value of $4,200,000
- Net equity of $540,000, or roughly double the net equity
of $273,000 without the tax benefits
- Annual appreciation after the seven years of $210,000 per
year
- All with a single initial investment of $20,000
So let's recap. If the investor had listened to a typical
financial advisor, the investor would have invested $20,000
in a mutual fund and, with a very good market, would have
$39,000 at the end of seven years. On the other hand, if
the investor had used the concepts of leverage and
velocity, including tax benefits, the investor would have
$540,000 at the end of seven years and a portfolio worth
over $4 million.
What's amazing about the concepts of leverage and velocity
is that they are not limited to real estate. They work
equally well in business and in the stock market. But if
these concepts are so great, why doesn't' the average
investor use them? The answer is simply, KNOWLEDGE AND
EFFORT.
There is one final factor - EFFORT. It is easy to give
your money to an investment advisor and it is easy for the
advisor to put the money in a mutual fund. It is not
nearly as easy to gain the knowledge necessary to put the
concepts of leverage and velocity to work in real estate,
business or the stock market. It takes effort, both from
the investor AND from the investor's advisors.
Warmest Regards,
Tom
----------------------------------------------------
Tom Wheelwright is not only the founder and CEO of
Provision, but he is the creative force behind Provision
Wealth Strategists. In addition to his management
responsibilities, Tom likes to coach clients on wealth,
business, and tax strategies. Along with his frequent
seminars on these strategies, Tom is an adjunct professor
in the Masters of Tax program at Arizona State University.
For more information, visit http://www.tomwheelwright.com
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