A few years out of college, I had a very modest, but growing, 401(k) balance.
I had been taking full advantage of my employers’ matching programs, plus saving a little extra on top. I was diligently following the advice I learned in business school, which was backed by conversations with co-workers, online research, and good ole Dave Ramsey.
But something didn’t feel right.
I was checking the balance one day (which I did far too often) when an extreme sense of discouragement washed over me.
Sure, it was nice seeing the balance consistently going up. But that day, I realized regardless of whether that number went up or down, it had absolutely zero impact on my daily life.
I shrugged off the discouragement. After all, I was following The Plan™: work 30+ years, save into a 401(k), and retire off that nest egg.
Plus I had a finance degree - if there was another way, surely I would have learned about it in school. And this was the same advice preached by every finance expert. It all had to be right, right?
Unfortunately it would be several more years until I really understood the many flaws of The Plan™.
But, ignoring the fact that I couldn’t actually touch what was supposed to be my money for 30+ years (another topic for another time), what discouraged me the most that day was a simple realization: for this growing pile of money to be of any practical use, I would have to sell part of my investments.
That didn’t sit well with me. If I sell, it cuts into future growth. That capital is no longer working for me. Plus there’s the risk that I run out of assets to sell.
Although I couldn’t articulate it at the time, there was one thing I really wanted this pile of money to do: consistently hurl bricks of cash at me, without the pile getting smaller.
But stock market-based investments aren’t really designed to do this. Yes, there are “high-yield” dividend stocks. But even those yields are paltry compared to alternatives outside the stock market. Not to mention they’re still stocks, and are subject to the market’s irrational volatility.
Most folks investing in traditional stock market-based investments are really just playing a game of “number go up.” As their account balance increases, they feel wealthier (a phenomenon known as the wealth effect). But that number going up makes no practical difference in their daily lives.
And at the end of the day, if your investments can’t translate into cash that you can use, what good are they?
Wealth that exists only on paper is as useful in daily life as the paper it’s printed on.
Said another way, you can’t eat equity.
So if you have investments that are growing but don’t produce useful cash, what’s the solution?
The standard advice is to sell part of your investments for cash. This is the whole basis of a “safe withdrawal rate” and the “4% rule.” The idea being that you can sell 4% of your portfolio each year in retirement and (theoretically) never run out of money.
But while selling assets does produce cash, it has significant downsides. It’s tax inefficient, and you break the compounding effect (Einstein’s 8th wonder of the world).
One of the reasons I gravitated to real estate is because of how well it solves this problem:
Tax-advantaged, inflation-resistant cashflow
Long term (and forceable) equity growth
Favorable debt
The last point might be the most important for this discussion. The ease of getting debt on real estate turns equity into cash in a way that:
Doesn’t disrupt compounding, and
Doesn’t create a taxable event
In other words, it provides an efficient way to eat your equity without having to sell assets.
But my broader point here isn't to make a case for investing in real estate specifically. It’s that acquiring a portfolio of cash flowing assets that
produce usable cash today, and
you never have to sell
is far superior to acquiring paper-only “number go up” assets that:
produce nothing today, and
have to be sold for cash.