Investigate: Millionaire or Not?
The story appeared a month ago and I read it, scratched my head, wondered if it was true and moved on. The headline “A 27-year-old millionaire reveals how he built his wealth” made for effective “click bait” given the public’s fascination with millionaires (check out my list of best selling personal finance books and you get the idea). Well, it turns out it wasn’t true. I thought it might be fun to have your students play forensic accountants to see if they could find the errors in the story. This case study is a good one because it incorporates concepts such as investing, net worth, mortgages, rental property, savings rates and “you can’t always believe what you read.”
Here is a summary of the financial facts presented:
- First job at 15; worked three years at Subway and saved 100% of his earnings; had saved about $10,000 when he graduated high school.
- Worked from 18-20 in administrative jobs; unsure how much he earned or saved.
- At age 20 (say 2007) joined Navy earning $55,000/year as electronics technician
- Saved 60% of his earnings at Navy and did freelance jobs for $15,000 – $20,000/year saving $40,000 – $45,000 per year
- Didn’t sell during downturn
- 2009: put down $80,000 on $400,000 condo in San Diego which he rents at $3,000/month; says he saves $12,000/year after paying mortgage ($320,000)
- 2014: purchased $430,000 duplex which he rents out at $21,000/year and earns $12,000 net after the mortgage is taken into account.
- 2013-14: Earns $100,000/year and saves 50% in addition to his rental income
See how your students do in coming up with the problems with his “story:”
- $55,000 seems high pay for high school graduate in entry level navy position; Payscale provides median pay for this position in the Navy as $43,326 so that seems high as a starting salary so may just be his ending pay after 6 years.
- If you incorporate federal payroll taxes of 22.5% (average tax rate on his reported income of $80,000) that leaves after-tax income of $62,000 so to save $45,000-$50,000 would require spending just $12,000-$17,000 per year; seems difficult to live on but military life may make it possible.
- Navy: The bulk of his savings came during his period in the Navy from 2007-13. Let’s assume he saved $45,000 per year for six years and invested in what he described as a “lazy portfolio:” “Ivanov decided to invest in seven asset classes: domestic, large-, mid-, and small-cap funds, emerging market funds, commodity funds, with a small chunk in bonds. Then he let it ride. He rebalances his portfolio once a year, if at all.
- “Students could create a spreadsheet to see if they can replicate his investment results. Since we don’t know his asset allocation, I will simplify by just assuming he achieved a return equal to the S&P500 for that year (Yahoo Finance has this data). Since he bought a house in 2009 with $80,000 down payment we will withdraw that amount in 2009. Also, needed to cover downpayment of $86,000 for the $430,000 duplex. I created an answer sheet here: MillionaireClaim. Using the assumptions above, the value of his investment portfolio would be about $246,000 at the end of 2013
- So, what is the value of his real estate?
- Condo 1: $600,000 value – $320,000 mortgage = $280,000 equity (Note that mortgage would likely be lower, so equity would be higher since he had been paying it off for 4-5 years).
- Duplex: $430,000 purchase price – $344,000 mortgage (assume 20% down payment) = $86,000 equity
- Note that I didn’t incorporate the rental income form Condo 1 that he has received since 2009, which would have amounted to $12,000 per year for 5 years or $60,000.
- Net worth:
- Investment portfolio: $246,000
- Condo 1 Equity: $280,000
- Duplex equity: $ 86,000
- The results show him coming up about 40% short of the $1,000,000 that he professed to have in 2014. Good lesson: don’t believe everything you read. The reporter later wrote a correction on how she had been hoodwinked.
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.