Are you tracking your balance sheet—or flying blind?

But who’s looking after our assets?  The majority of the mass affluent and HENRYs are flying blind, without a view of their balance sheet (or even a guess) and without an advisor steering the ship.  Are you making mistakes that when compounded could be costing you millions?

Income fuels savings, but the real separation over 5-10 years comes from what your assets and liabilities do in-between deposits. Once you can see the whole balance sheet, you can make a handful of high-impact moves that actually change the slope of your net worth line.

When you can see every asset and liability tied back to a source document, you can act decisively on the big stuff: real estate that eats equity, bond sleeves that behave like a handbrake, and concentrations that threaten a multi-year plan.

A quarterly refresh lines up with statements and supports rules that have evidence behind them, like tolerance-band rebalancing and timely bond sleeve changes, instead of set-and-forget. 2022 was a wake-up call: the classic 60-40 fell roughly 17-18%, its worst since 1937, because stocks and bonds sank together. (Morgan Stanley)

Many individuals buy real estate based on stylized numbers, set it and forget it.  BUT, when you put the actual numbers on a spreadsheet you will see a very different story.  Sure your real estate manager’s fee is only 8% of rent so you should be collecting 92% of rent, right?  Wrong!  

Most experienced investors are using a 60-70% margin of Net Operating Income to Rent and I’ve seen properties dip to <30% during turnover years.  Did you know that your RE management office is incentivized to turn over your rental every year and find a new tenant?  That’s because they get very hefty “new tenant” fees that can easily eat up half a month’s rent.  

The bad news for you is that you run the risk of vacancies (i.e., lost months of rent) AND you have to pay the “new tenant” fee.  You also have to cover hefty turnover expenses upon moveout, e.g., refreshing the pain and fixing things that broke from the previous tenant.  But probably none of these expenses made it to your original “investment” spreadsheet.

So it’s a good idea to monitor your properties monthly or quarterly to see if you’re getting a goodo enough ROE.  You should also ask an experienced real estate agent for how property values are trending in your area.

If you’re generating 5% ROE (after your interest expenses), this can be equivalent to 8% pre-tax equivalent return because you can offset any income with depreciation.  And on top of that you can add real estate price appreciation: if your area is appreciating at 3% and you have 50% leverage, that’s another 6% of value, which combined comes up to 14% pretax ROE.

But if your numbers are significantly lower - which can also happen as a result of building up too much equity that suppresses your ROE and the leverage on appreciation - you may need to adjust your strategy, e.g., increase your leverage with cash-out refinancing or a HELOC, sell and do a 1031 election to find a higher cap-rate property while deferring capital gains taxes, or just sell and invest in a superior investment or even the stock market if you’re overweight in real estate.

If you own a lot of investment real estate, or you plan to make this a pillar of your wealth management strategy, it may also make sense to look into becoming a real estate professional so that you can take active depreciation against your income outside of your investment real estate.  In that case, you can do cost segregation studies and evaluate the bonus depreciation on eligible assets, and how much of your income you could shield from these “losses”.

How much can it matter

Example, not advice: a $1.2M rental with $700k equity and $42k NOI is a 6% ROE. Exchanging into a like-kind asset at a 7.5% cap with similar risk raises annual income to ~$90k on $1.2M, which can lift ROE toward the low teens depending on financing, while deferring the exit tax under 1031. Even a 2-4 point ROE lift on mid-6-figure equity is real money over a decade. (look at IRS’ instructions for 1031 “like-kind exchanges”)

What went wrong

In 2022 both stocks and bonds fell, so the usual stock-down, bond-up ballast failed. Many investors held long-duration bonds that bled as rates rose. The 60-40 portfolio dropped 17.5%, the worst since 1937.

What to consider

How big can the drag be

Holding long-duration bonds into a rate spike can cost double-digit percentage points in a single year. Flipping the sleeve to shorter duration after a holistic review does not chase 10 bps. It can be the difference between a minus-teen year and a survivable one when the regime turns. The point is not to abandon balance, it is to own a bond sleeve that behaves the way you need it to.

Also, don’t forget that 40% bond exposure can be a real drag on returns during a stock market boom.  And missing out these booms makes all the difference for long-term returns.  The market is volatile and you don’t want to lop off the good years because you’ll never recover from falling behind.

It’s one thing to consider that you should be diversifying your investment with private equity or direct investments into private projects; and you get completely different conviction if you see that your peers allocate X% of their net worth in such projects already.

The Federal Reserve has a very interesting survey of consumer finances over the years.  You can see all the asset and debt allocations of households by income level. (Federal Reserve, Survey of Consumer Finances, SCF)

For example, here’s a 2022 snapshot of the 90-100th percentile households (by net worth).  They have an average annual pretax income of $633K and net worth of $7.8M.

And this is their asset allocation breakdown:

Ideas you can pull from peer data

Specific things you can do this quarter

A holistic, source-linked view lets you attack those three problems in order: fix property ROE with real tax and financing tools, redesign the bond sleeve so it behaves when it counts, and use benchmarks to set a next rung that is ambitious and credible. That is how a dashboard becomes an engine for compounding. And this is just the beginning!

This newsletter is for informational and educational purposes only and should not be construed as personalized financial, tax, legal, or investment advice. The strategies and opinions discussed may not be suitable for your individual circumstances. Always consult a qualified financial advisor, tax professional, or attorney before making any decisions that could affect your finances. While we strive for accuracy, we make no representations or warranties about the completeness or reliability of the information provided. Past performance is not indicative of future results. All investments involve risk, including the possible loss of principal. The publisher, authors, and affiliated parties expressly disclaim any liability for actions taken or not taken based on the contents of this publication.