facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog search brokercheck brokercheck Play Pause

Investing Once Traditional Methods are Maximized

The basics of investing are the same for everyone. But what different approaches exist once the initial steps have been taken?

Investing is a challenging topic, and one that we’ve addressed from various angles on our blogs:


How to choose a 403(b) vendor                            Investing for different goals


What’s the big deal with interest rates?         How should I invest my 403(b)?


But there are times when I meet with clients or discuss topics with readers in which they have done everything I would suggest:

-       They max out their Roth IRAs

-       They make contributions to (or even max out) their 403(b) / 401(k) – and it’s not an insurance-based product

-       They are contributing to 529 college plans for their children

-       They are making investments in a taxable account

For most people in this situation, they have a large surplus of income as making maximum or sizable contributions to these accounts would be over $30,000 per year per person. While taxable investing doesn’t have an income limit on it, when families are investing more than $50,000/year to an account like this (on top of retirement savings), it can be time to look at other options.

In that case, investing takes some out-of-the-box thinking to add another layer of diversification.


Investing in your home (upgrades and mortgage payments)

Our homes have an emotional component to them – we’ve raised children in them, we’ve celebrated holidays there and seen some major life milestones occur in the rooms where we live.

But houses can also be viewed as an investment should you desire to sell them at some point.

When looking at your home, it can pay to upgrade the important rooms in the house – kitchens and bathrooms. But you should also be looking to see if you should be adding on square footage to your home as well. Is your home one of the smaller ones in the neighborhood? If so, adding another bedroom, finished basement, or connected living space could significantly add to the value of your home when you come to sell in the future.

But what if I told you that by investing in your house, you can also make a guaranteed 3-6% return on your money? This method, unlike doing improvements which pay off when you sell the home, is a guaranteed return felt immediately. The rate of return is calculated by looking at your mortgage interest rate. By paying off an extra $1,000 each month, that’s an extra $1,000 that isn’t being subject to 3-6% interest – so you’re essentially earning 3-6% on that extra money you pay every time you do it.

Pay off your mortgage. Many advisors I know scoff at this idea – they look at low interest rates and the tax deductibility of a mortgage and say “the bigger mortgage, the better”. But what if I asked you this question:

“If your house was paid off, would you borrow $100,000 against it to invest in the stock market?”

For 99% of people, the answer is no – it doesn’t make any sense. Why risk a paid-for asset that provides shelter to your family for an unknown return that might take a while to pay off. But look at your situation now – do you have money that could be going to paying down your mortgage that is going into taxable investments? Maybe it’s time to start paying off your mortgage and investing in your home by reducing the debt you owe on it.


Investing in real estate

As a prudent advisor, my advice for people is to pay off their house first before investing in rental real estate. Some clients agree, others look at me like I’m from outer space! Either way, it’s their money to invest and they choose what to do with my advice.

Whether you pay off your house first or not, purchasing rental real estate can be a way to generate income now - to either pay down the rental mortgage or use for other purposes – and also purchase an asset which will appreciate until a future time in which it is sold. While the amount of appreciation is very location-dependent, it can be almost guaranteed by purchasing houses at well below market value. This requires research, timing and some luck, but investment real estate can be an added diversifier to a portfolio. When it comes time to retire, and your rental property/ies are generating income each month, this can help you delay withdrawing funds from retirement accounts and delaying taxation on these funds.


Investing in life insurance and annuities

Ah, the topic that gets slammed by some and loved by others. To cut to my opinion – insurance products can be used for specific investment purposes when all other avenues are exhausted.

For example, a client at a previous company I worked for had investments in the $20,000,000 range. Because his portfolio was diversified he had a significant bond portfolio that was generated taxable income each year. His W2 income placed him in the highest tax bracket already, so this bond income was subject to taxation at over 40%, when all was said and done. Even if he held certain municipal bonds, he would have been subject to AMT taxation on the tax-free income. Given his portfolio, he may not even need to spend that money, it could just be passed on to his heirs – so why pay taxes on it? For that reason, it was decided to put as much of his bond portfolio as was allowed into an annuity. An annuity product offered by Jefferson National allowed to use an stripped-down, no-frills annuity and bypass many of the fees associated with this type of product. He was then able to defer taxation on this part of his portfolio, and would most likely defer it to his heirs at his passing.

But not everyone has $20,000,000. If we did, life would be different!

Still, if it is likely you won’t use part of your taxable portfolio during your lifetime, sheltering it inside of an annuity product can provide immediate tax savings.

The same can be said for permanent life insurance. Putting money that would have been used for taxable bond positions into a life insurance product can shield you for paying taxes on the income it currently throws off.

“Being your own bank” is a philosophy that is discussed when using life insurance and relates to overfunding a policy (by paying more than the premiums so the cash value grows faster) so you can withdraw a steady amount of income later in life. While you have to be very selective with the policy you use, a policy that pays a high rate of interest on the cash value can make this approach a viable addition to traditional investing.


Investing in a non-public company

Traditional investing takes place using companies that are publicly traded. When you invest in your 401(k) or taxable account, you are doing so in companies that have “filed to go public” and list on a public exchange. They can be small or large, in the US or outside. But by giving everyone access to investing in them, it does not give investors a chance to achieve monumental gains in their position.

For investors who want to take risk in private companies for the chance of oversized returns, then it can be done in two ways.

For investors wanting small companies, then they should use a business broker or attorney to find these companies and see if they need outside investors. These brokers and lawyers can then draw up terms making sure everything is treated fairly. By making significant cash investments into a company, then an investor can own a portion of a company that would be hard to afford on the public exchange. Imagine trying to purchase 10% of a public traded company? It would be very expensive, costing millions of dollars! But for smaller, non-traded companies, it may be done for hundreds of thousands of dollars.

You can also become an accredited investor, which by verifying your income and investable assets, companies who have gone through seed rounds will allow you to become an investor. You would provide an amount of money to a private fund and they would invest for you, sometimes allowing you to specify which companies you would like them to invest in. It’s not as transparent as using a publicly-traded mutual fund, but this approach can garner some outsized rewards.


Investing in people

Social Investing a recent phenomenon. Sites like Prosper.com, LendingClub.com and Kiva.org allow you to invest in the lives of business owners in third world countries, or people needing lower interest loans. Known as micro loans, you would look at the profile of a borrower, determine if you’d like to invest in them and their proposal and be one of multiple people investing that loan. By doing this for multiple people on the site, you can diversify the money you have invested, as some borrowers will naturally default on their loan. But for those who do repay, the interest rates for lenders can be quite attractive.

By building a portfolio of loans through this program, the amount that is contributed by an investor is limitless. Given the fact that these loans can pay on average a 7% rate of return (given the interest rate charged to the borrower), it can be a stock-like investment with bond-like properties.


There are many alternatives, but do the basics first

The world of investing has many alternatives, but for most, investing in global stock markets through traditional mutual funds and ETFs is the best way to grow a portfolio. However, for those wanting exposure to different areas, with the potential for bigger returns (but with bigger risks), these alternative arenas may prove fruitful. You’ll also notice I haven’t suggested hedge funds in this article. I don’t believe hedge funds to provide value to an investor when you look at the long term performance of most funds. They are expensive (google “hedge fund 2 and 20”) and typically don’t produce the results for being so expensive.