The cost of keeping up with the Joneses

By Alexander Bermudez

In this increasingly material world we live in, many people find themselves living beyond their means, and the prospect of investing takes a back seat to consumption. Ironically wealth is so coveted by our society, many people, not disciplined enough to invest, take the easy road and consume, often more than they make, in an effort to appear wealthy.

Our culture seems to promote this behavior, how many times have you heard the term, “rich man’s car”? A car may be expensive, however this does not make the man who drives it rich, surely any car a rich man drives regardless of price, quality or condition is a “rich man’s car”, after all, it is the man who defines the car.

Not content with the facade of keeping up with the Joneses, many high net worth individuals resist the temptation of conspicuous consumption, in favor of investing. As any investor worth his salt will tell you “the sooner you start to invest, the greater the benefit of compound appreciation will be”.

To illustrate the point we will use a hypothetical building for sale today priced at $1,000,000. Let us say you put a down payment of $350,000 and financed the balance of $650,000. We estimate the value of the property will increase by 7% annually; by this measure it will double its value in ten years.

After ten years your building is now worth $2,000,000. You decide to refinanced leaving $700,000 of equity and employ the cash out proceeds of $650,000 and a mortgage of $1,150,000 to buy another building for $1,800,000. You now control a total of $3,800,000 of real estate, the original building now worth $2,000,000, and your new acquisition valued at $1,800,000. Your equity at this time is $1,350,000.

Another ten years have passed and your real estate portfolio is now worth $7.6 Million. You refinance for the second time leaving you with 2.7 Million in equity in the first two buildings, and employ the cash out proceeds of $2.45 Million and a mortgage of $4.55 Million to buy another building for $7 Million. You now control a total of $14.6 Million of real estate, the new $7 million purchase plus the prior 2 buildings worth $7.6 million, and your equity is now $5,150,000

Ten more years pass and you are still a firm believer in the buy and hold strategy, your real estate portfolio is now worth 29.2 Million and your net equity is $19.75 Million. You have $9.45 Million in mortgage obligations, which your tenants are paying off for you.

We now can see how compounding $350,000 over a thirty-year period can result in $19,750,000. But if you only have 20 years to compound, your equity drops to $5,150,000. Those lost ten investment years cost you $14,600,000!

As you can see the opportunity cost of deferring your investment strategy is exorbitant. So forget the Joneses, live below your means and save for a down payment! If you wait, there will be less time for your money to compound, and the consequences will be very costly. Remember the loss comes off the thick end of the investment wedge, when the greatest amount of money is compounding.