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BiggerPockets Money Podcast
The Middle-Class Trap That Could Keep You from FIRE (How to Escape It)
00:41:46
Buying a house, maxing out your 401(k), and leveraging real estate can help you achieve financial independence. But suppose your goal is to retire early. Could relying too heavily on these principles actually delay early retirement? Today, we’re going to show you how to break free from the “middle-class trap” that stops so many from retiring early! Welcome back to the BiggerPockets Money podcast! Is most of your net worth “stuck” in home equity and retirement accounts? This is a widespread issue in the FIRE community. On one hand, you could sell your home or refinance your mortgage to tap into your equity, but interest rates are too high! Meanwhile, you can’t withdraw money from your 401(k)—not without incurring severe penalties. In theory, you could already be a millionaire but have little to no cash flow to fuel your retirement. So, what should you do? In this episode, you’re going to learn all about the middle-class trap, how to avoid it, and, if you’re in it, how to get ...
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- [00:00]
Mindy Jensen
One of the biggest fears of people in the FI community is ending up in the middle class trap. Landing here could delay your retirement for years. But don't worry. Scott and I are going to dive deep into how to escape the trap. There is a way out. Hello, hello, hello and welcome to the BiggerPockets Money Podcast. My name is Mindy Jensen and with me, as always, is my Not Trapped co host, Scott Trench.
- [00:24]
Scott Trench
Thanks, Mindy. You're just so good at chaining together all these wonderful different intros that are so relevant to whatever we're talking about every day. BiggerPockets has a goal of creating 1 million millionaires who are not caught in the middle class trap. You are in the right place if you want to get your financial house in order, because we truly believe financial freedom is attainable for everyone, no matter when or where you're starting. Mindy, I'm super excited to get into this today because we ran a YouTube poll to the BiggerPockets money audience and the middle class trap was one of the top two problems that folks wanted us to provide answers to. The other being most of my wealth is in index funds and I don't know how to actually harvest that for cash flow, which we need to cover at other times and something I've been grappling with as well. But this is the one we're going to focus on, the middle class trap. And we should start by defining it. How do you define the middle class trap?
- [01:08]
Mindy Jensen
Mindy the middle class trap is what happens when you have been super good with your finances. You bought a house like you're supposed to, you invested in your 401k like you're supposed to, and all of a sudden you find yourself a millionaire on paper. All of your net worth is actually tied up in your home equity and your pre tax retirement accounts. The problem is you're not going to sell your house in order to access that equity. You still need a place to live or you're probably not going to sell your house. You are also not going to refinance and pull some of that equity out because chances are really good you have a better rate on your mortgage now than you would get if you refinance. On the same token, your Pre tax for 1k is awesome for reducing your taxable income. But you can't access those funds until what age, Scott? Can you. Can you access them at 55?
- [02:02]
Scott Trench
59 and a half, right?
- [02:03]
Mindy Jensen
59 and a half. And if you do access them beforehand, you're paying a 10% penalty plus you're paying taxes on all the money that you're taking out. So millionaire on paper is awesome, but you need to be a millionaire accessing that million dollars in order to, to be able to spend it. So that's why we call this the middle class trap.
- [02:24]
Scott Trench
I agree. I'll add a couple more nuances there. The middle class trap as I describe it is you do everything right. And that's the frustrating part about this, right? You're two like imagine a two income household or with kids, two and a half kids and a dog and a two car garage and all that kind of good stuff. Each making, you know, somewhere between 50 and $80,000 a year on that front, doing well on paper, contributing to the 401k, contributing to paying down the mortgage, maybe have reasonable cars that are fairly new with, with some payments on them that they're making and they're just looking up and like well my net worth is a couple hundred thousand dollars, maybe even over a million at. It's all in my home equity, it's all in my retirement account. If I were to stop working or one of us was to stop working, we would start running out of cash in a pretty remarkably short time period. What the heck is going on? We seem to be making all these decisions and not getting ahead. That's the middle class trap and there are many variations of it. But the one that we're going to talk about today is a millionaire to $1.5 million net worth that is all stuck in assets that seem unharvestable for the individual. And we're going to talk about how to change either dramatically, the different ways to get out of there, either gradually or dramatically to access that capital and actually have it begin producing freedom in your life right now. And the trade offs that go with that.
- [03:42]
Mindy Jensen
Awesome. So Scott, in a perfect scenario, what is the ideal portfolio so that you're not in the middle class trap? Let's say that you have just a pile of million dollars, 1.5 million. Where would you put it so that you would not find yourself in this middle class trap?
- [04:01]
Scott Trench
I can give you a couple of answers that and by the way, there's no way to answ to this in a way you're going to like as a listener, right? Like you will have. The middle class trap is there because so many of the decisions that put you in the middle class trap are textbook decisions that go that have, they have a healthy balance of life and long term tax advantages to them. So let me give you an example. Middle class trap, right we talked to this couple a while back. They're based in Colorado. $1.5 million net worth, roughly speaking, 500,000 of that was in their home equity. Their home was worth 800 grand. They had $300,000 mortgage left. Another 500,000 was going to be in retirement. Another $500,000 was going to be in two rental properties that were highly levered. Maybe $500,000 in equity against $1.2 million in asset value. So $700,000 in additional mortgages and then a little bit of a sprinkling of cash and credit card debt in addition to that. That portfolio produced effectively no cash flow for them. And while they were able to continue contributing and paying down these mortgages over time, they just weren't getting ahead. That's a middle class trap portfolio. For example, even though that includes some rental real estate, let's take that same amount of net worth and let's just tweak some numbers. That house, the $800,000 house, paid off, no mortgage. There's one rental property, that, and that, that, that clears up $30,000 a year in P and I payments on the remaining balance of that, that mortgage. Right? Then the rental property, there's no, there's one rental property that's paid off there in the $400,000 range and that's producing, let's call it 20 grand a year in cash flow. That's a swing of $50,000 a year and less income that this family has to realize to pay for their lifestyle expenses. And then let's say that we have maybe $400,000 in mostly in an after tax stock bond portfolio that's producing maybe 3%, 4% blended yield on that front. That's another $12,000. So that position is not financially free. We're not in a financially free position because so much wealth is in the house. But you can see how much more cash is going to flow into this couple's bank account with that portfolio tweak. And that, no, that's not what I would be recommending. That would just be like one set of moves that, that, that, that family could make that would make them have a lot, be a lot less dependent in the near term on having two full time income earners. So we'll get into the nuances of how to actually think about this and the trade offs. I told you, you are not going to like it. That's not a, none of us like that move. And I'm not saying they should do that. It's just that's the Kind of thinking that we have to start with to figure out how we move the chess pieces to get out of the middle class trap.
- [06:29]
Mindy Jensen
All right, so I hear what you're saying. Not having a mortgage payment is awesome, but you're advising them to pay off a large chunk of this pretty low interest rate loan just to free up that amount. Is there any others? What would you say to somebody who says I do not want to give up my 3% mortgage?
- [06:51]
Scott Trench
Well, look, I think, I think escaping the middle class trap is fundamentally comes down to a question of am I optimizing for some future state total net worth number or am I maximizing for nearer term flexibility? And there's not a wrong answer to that. The middle class trap is not a problem if you do not intend to retire early. It is just a problem if you intend to retire early. And the mortgage payments a great example of this. We had a very lengthy debate about paying off your mortgage or not a while back and you did not want to pay off your mortgage. And I decided to pay, dude, pay off my mortgage on that front. And I think that there's. When you're getting close to the journey and finishing the play to financial independence, not having a mortgage payment drastically reduces the amount of income that you need to realize either from your work or from your portfolio, which makes the game a lot simpler. And you know over most 30 year periods you're going to do better investing in the stock market and taking an index fund 7 to 10% long term yield that the stock market historically produces almost over every 30 year period. But you know you're going to be freer if you pay off the mortgage sooner. And that's the fundamental again, that's why this is so hard. When we talk, think about escaping the.
- [08:09]
Mindy Jensen
Middle class trap while we're away. Dear listeners, we would love to be able to hit 100,000 subscribers on YouTube and we need your help. While we take a quick break, you can go on over to YouTube.com biggerpocketsmoney and subscribe to the channel. Want to invest in real estate but don't have the time or know the best local markets? Rent to Retirement has you covered. Here's the deal. They've helped thousands of investors just like you find turnkey homes across the best US markets. And best of all, they do all the heavy lifting for you. With over 250 five star reviews on bigger pockets, Rent to Retirement experts help you build strategies to retire early through real estate. And right now, Rent to Retirement offers some amazing incentives on turnkey New construction properties like up to $30,000 off new build price prices 0% down loan options 3.99 interest rates available don't miss out. These deals won't last. Text REI to 33777 or visit biggerpockets.com retirement to start investing in top cash flow markets today. There was a time when real estate investment was a playground only for the wealthy and well connected. The barriers were high and the opportunities were few. Not anymore. Thanks to Connect Invest. With Connect Invest, you can unlock premium real estate deals with just $500. Now your money can grow through fixed returns deposited directly into your account every month. It's not just investing, it's securing your financial future with a steady income stream and hassle free investing. Visit biggerpockets.com connect invest and start your journey towards financial freedom today. That's biggerpockets.com Connect Invest listener a new year is finally here. And if you're anything like me, you've got a lot on your plate. Habits to build, travel plans to make, mocktail recipes to perfect Good thing our sponsor, NerdWallet is here to take one thing off your plate. Finding the best financial products introducing NerdWallet's best of awards List your shortcut to the best credit cards, savings accounts and more. The nerds have done the work for you, researching and reviewing over 1100 financial products to bring you only the best of the best. Looking for a balance transfer credit card with 0% APR? They've got a winner for that. Or a bank account with a top rate to hit your savings goals? They've got a winner for that too. Know you're getting the best products for you without doing all the research yourself. So let NerdWallet do the heavy lifting for your finances this year and head on over to their 2025 Best of Awards at NerdWallet.com awards to find the best financial products today.
- [10:41]
Scott Trench
Welcome back to the show.
- [10:43]
Mindy Jensen
I like that you acknowledge that it's hard. This is not an easy fix. This is not an easy solution. Scott and I aren't going to say, oh, just do ABC and blam. You have escaped the middle class trap. It's not that easy. I think you hit a good point, Scott. You said, do you intend to retire early? We've spoken with a lot of people on this show who are pursuing the fi part of financial independence, but they like their job. They're not actually looking to retire early. Early. So if retiring early is not your goal, the middle class trap is far less of a problem. However, that's real easy. Okay, Those people are taken care of. Now we're going to talk to the people who do intend to retire early. Again, you haven't done anything wrong by maxing out your 401k and buying the house and having, you know, equity buildup in your home. But you have done. And I mean that's, that's been the, the, the advice. Oh, max out your 401k, build your wealth. That's great for traditional retirement. If you find yourself a millionaire on paper, there are things that you're going to have to change in order to be able to retire early. And one of those things, the biggest thing you're going to have to change is your asset allocation. Are you investing in your 401k maxing that out? Do you have a Roth option? You are trading the reducing, reducing your taxable income for accessing your retirement funds early. So talk to your employer. If there is a Roth option, perhaps that's the way to go for you. You can pivot from investing in the stock market through your 401k to investing in the stock market in an after tax scenario. Again, if you're not maxing out your 401k, you are not reducing your taxable income by that much. So you will be paying more income taxes, but you're building after tax wealth that allows you to access these funds until you can access your retirement funds.
- [12:48]
Scott Trench
Let's make up another example here. Let's say we have somebody with 500,000 in equity in their home, an $800,000 home and they've got $1 million in retirement accounts, essentially all in a 401k. Super simple, unrealistic example. Many people have more complex situations than that. But let's just take this situation here, right? How do we help this person? This person is sitting there and they got 10 grand in their bank account and $5,000 in the credit card balance. So they run out of cash and two paychecks if they stop working. Basically this is how a lot of people I think live. There's a cars, there's loans, there's all these other kind of other things in place there. But generally they're getting ahead and contributing to their retirement and they're a millionaire. This is a millionaire. This is a 1.5 million dollar net worth household. And we've talked to people that are actually fairly close to a situation like this on Biggerpockets money in the past. So you say I want to be financially free tomorrow. Well, we have one answer to that that you're really not going to like I want to be financially free in five years. We have an answer to that that you might like more and I want to just continue what I'm doing through to retirement there. There's three different approaches to how to handle this. Let's say that, let's take the middle ground for how we can move this person on a path toward financial freedom in five years at the framework level. Right. Again, let's say they have $300,000 left in their mortgage and that million in the 401k. One answer is to say okay, this couple, this person, this couple is probably assume it's a married couple are married couple with two and a half kids example here. They're probably able to generate. They're clearly generating more than they spend because they're contributing heavily to the 401k. That's how they have a million doll that 401k. But they're also facing a problem here, right? This is not a couple that's earning so much that they can go through the classic finance influencers playbook that are all slight permutations of a formula that everyone uses right here of like how do you save? Well first you max out your emergency reserve, then you take your 401k match, then you max out your HSA, then you do your Roth, then you do your 401k until the balance and then you invest in your after tax brokerage which almost everyone you talk to is going to have a variation that's almost verbatim that particular flow here. The problem this couple has is they can't quite get through that whole thing because they don't have $75,000 to invest, they have 50,000 to invest and that's why they never get to accumulating wealth outside of that 401k or those retirement account balances is because they go down that needs stack and there's just not enough income, not enough leftover before their expenses to actually build up wealth meaningfully anywhere else. So to begin unwinding this problem, if they wanted to retire, if this is a 40 year old couple and wanted to retire in five years, an approach that could work might look like this. We're going to stop contributing to the 401k. We might take our match and that's it. We're going to stop maxing out the hsa, we're going to not do the thing that the finance influencer textbook says to do and instead we're going to pay our taxes and we're going to be left with $35,000 after tax, that will actually hit our bank account and we're going to pay off that mortgage early and that is going to have a whole bunch. That means I'm going to pay more in taxes and I'm not going to invest in the stock market over that time period. But what you're going to end up with is three, five, seven years from now, you're likely going to have that mortgage paid off and the $30,000 that you need to pay in principal and interest on that mortgage are going to be gone, which is going to reduce the pressure on your situation for both parties to work. For example, one could maybe do some sort of entrepreneurship or whatever. The second thing that's going to happen is over a five to seven year period, historically this may not happen. You cannot count on this happening. But you can analyze formulaically that this is the average outcome that has happened is the stock market will roughly double every 7.2 years at a 10% yield. Okay, so if your 401k accounts are in there, they will still grow. You may end up with $2 million at that point and a paid off house. Now things begin to get interesting. Now we still have the problem of the Money in the 401k, but we can actually start beginning to back in our minds into how can I actually harvest that? Can I put some of that into a bond fund? Something very, very safe, for example, or maybe even like a syndication or something like that. That would produce some yield and can I start to harvest some of that? There's a program called the Substantially equal Periodic payments, for example, where you can begin. If you commit for life to taking out some amount of money from your 401k, you can do that penalty free. You'll still pay taxes on it. But now, hey, okay, at 47, I have this portfolio. I got a paid off house and I've got my 401k balance that has grown to some degree. I take some percentage of that and I begin harvesting just 1 or 2% of the balance of that on an annual basis. That makes a big difference. 2 million times 1% is 20 grand. With $30,000 and less P and I payments from your mortgage and $20,000 coming in from your 401k through these substantially equal periodic payment plans, the pressure begins to ease dramatically. It's a $50,000 swing in cash flow. That's a full time $65,000 a year job from one of the spouses here. That does not have to be worked in that situation. So that would be a way to begin thinking about bridging this difference and achieving some sort of freedom from someone starting in that traditional middle class trap position again. I told you you weren't going to like it, though. That's one example. So what do you think, Mindy?
- [18:31]
Mindy Jensen
I don't like it, but I see where you're going, so that isn't the route that I would choose. I do like the 72T. I do have to make a couple of corrections to what you shared. You don't have to take the 72T for life. You have to take it for a minimum of five years or until age 59 and a half, whichever is longer.
- [18:50]
Scott Trench
Sorry about that. Yes, thank you.
- [18:52]
Mindy Jensen
Yes. And the stock market tends to double every seven or eight years, not every five to seven. However, all of the rest of that. Absolutely. I'm picking niche. I don't want to pay off my mortgage. I don't want to get rid of my 3% loan. So instead of doing that, I take that extra, I think you called it 35,000, and I start investing in accounts that I can access without paying fees that I don't have to be a minimum age to access. So your Roth ira, or if you make too much money, a backdoor Roth IRA that allows your money to grow, you can access the amount that you put in at any time. Even though you can't access the growth, the growth still stays there, still keeps growing. So that's a great way to access some of those funds. I would also start funneling funds into an after tax brokerage account. I have done well in the stock market. I have done well with, I mean index funds have done amazingly well. So that's another option going into the stock market in your after tax brokerage. Those are, that's money you can access at any time. And just for funsies, you can actually access a lot of the money in your after tax brokerage account tax free. Once you stop working, once you don't have income, it is something like $96,000 that you can access. You can pay no capital gains taxes on. I got this from Jeremy Schneider from Personal Finance Club over on Instagram. You can Access up to $253,400 tax free. When you have an after tax brokerage account. That's and that's per year. So in his example, he says Will and Whitney retired early. They withdraw $253,400 per year from their taxable brokerage and pay $0 in tax. Here's how $96,700 is the top of the 0% tax bracket for capital gains, $30,000 is your standard deduction, and $126,700 principal of investments sold in total. That means the couple can spend 253,400 of their investments in a year and pay $0 in tax. Of course, Scott and I are not tax professionals and you should absolutely consult one before you start doing this and be like, oh, well, Mindy and Scott said, so the IRS is going to be like Mindy and Scott who? But anyway, you can actually access a lot of these funds without paying taxes. So that's another way to go. You said don't contribute to the hsa. I am going to say maybe continue contributing to the HSA and stockpile your receipts. That's another way to pull money out of your retirement accounts and your the things that you've been saving so that you can get that money without paying taxes on it. I think that when people hear the middle class trap and we talk about, oh, it's just everything's in your retirement accounts or your home equity and they're like, oh man, I'm stuck. You're not stuck. You have a lot of options, but you do have to start redirecting your money in order to be able to take advantage of those options.
- [22:11]
Scott Trench
That's the big thing here, right? The middle class trap is this feeling of being stuck in a slog. And that's the idea is you can do this by diverting flows of cash, which I think is going to be easier for most people, or you can continue what you're doing and have a plan to make a hard cut and begin accessing the money that's in the hsa. So for example, if you want to continue contributing to the HSA and like Mindy said, store all your receipts over the course of the next five, seven years, maybe you spend 25 grand on health care. Actually you can put your insurance premiums on top of that as well. Right. And the HSA can reimburse. So store all those too on that. So you probably spend significantly more than that depending on whether your employer pays most of your plan or not. But you can, you could potentially have 50 or 60 thousand dollars worth of expenses over a 5, 10 year period for health care that can then be pulled out of your HSA tax and penalty free. And the growth and that HSA will have occurred tax and penalty free. So that's a great way to do it. As part of that, you have to get really savvy about these retirement accounts. But that's going to be a hard pivot for someone who's, you know, 35 or 40 and has a million dollars in that 401k or thereabout, grows it over the next seven to 10 years and then all of a sudden starts harvesting their HSA and starts pulling out of the 401k. If you can do that, that's great, have a strategy there. The mad scientist has put together some really thoughtful ways to do that. The challenge you're going to have at the fundamental level is most of that wealth is going to be in pre tax accounts, most likely like the 401k. And rolling that into post tax accounts will involve a decades long time frame. You know, you have to be thinking 10 years out, how do I actually, when I have low income begin to roll that money out of my 401k into a Roth in the early stages of retirement? It can be done, but I think it's just a lot lower probability than beginning now to build wealth outside of that retirement account, either by paying off the mortgage or by beginning those after tax brokerage account contributions. So and again, the problem you're going to run into is the textbook of maxing out the HSA, taking the 401k match and maxing out the 401 is likely going to leave you with nothing left to really begin doing that. Unless you actually make the hard suboptimal long term wealth choice of stopping continuing to pile up wealth into the middle class trap.
- [24:39]
Mindy Jensen
Yeah. And Scott, even hearing you say maybe you stop maxing out your 401k, I'm like, oh that sounds so wrong. I didn't max out my 401k last year and I did it on purpose. And you know, I, I funneled that money into different investments. But it was weird to not max it out. And I'm not in the middle class trap personally. I chose to. There were other investment opportunities that I had that I wanted to take advantage of. But it was still really, really weird to on purpose not hit the max. Especially now that I'm over 50 and I can get an extra 6,000 on top of that. I didn't get that either.
- [25:20]
Scott Trench
All right, what if you're already in the middle class trap? Don't worry, we've got you covered.
- [25:24]
Mindy Jensen
After the break, want to invest in real estate but don't have the time or know the best local markets. Rent to retirement has you covered. Here's the deal. They've helped thousands of investors just like you find turnkey homes across the best U S markets and best of all, they do all the heavy lifting for you. With over 250 five star reviews on Bigger Pockets, Rent to Retirement experts help you build strategies to retire early through real estate. And right now, Rent to Retirement offers some amazing incentives on turnkey new construction production properties like up to $30,000 off new build prices, 0% down loan options 3.99 interest rates available. Don't miss out. These deals won't last. Text REI to 33777 or visit biggerpockets.com retirement to start investing in top cash flow markets today. Every dollar you invest should work hard just like you do. Connect Invest Investing in real estate should be as simple as buying your morning coffee with Connect Invest. Start investing in diversified real estate projects with as little as $500, all from the comfort of your home. Picture the satisfaction of earning high yield returns every month without any of the headaches. Visit biggerpockets.com connect invest and start with just $500. Transform your financial future and join a community that's making real estate investing simple and accessible. Biggerpockets.com connect investors nerds hey guys, it's Mindy from the Bigger Pockets Money Podcast. If you're anything like me, you've got a lot on your plate this year. You've got summer beach trips to plan, a work life balance to balance, and pickleball opponents to best good thing our sponsor NerdWallet is here to take one thing off your plate. Finding the best financial products. Introducing Nerd Wallet's 2025 Best of Awards. List your shortcut to the best credit cards, savings accounts and more. The nerds have done the work for you, researching and reviewing over 1100 financial products to bring you only the best of the best. Looking for a lower rate on your auto insurance? They've got a winner for that. Or a balance transfer credit card with 0% APR, they've got a winner for that too. Know that you're getting the best products for you without doing all the research yourself. So let NerdWallet do the heavy lifting for your finances this year and head over to their 2025 Best of Awards at NerdWallet.com awards to find the best financial products today.
- [27:42]
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- [28:29]
Scott Trench
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- [29:00]
Mindy Jensen
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- [29:10]
Scott Trench
I mean, look, it comes down to cash and cash flow. If you have no cash and you have no cash flow and you have large cash outflows, you're going to be stuck working at the job for a very long period of time until that changes. And there are multiple ways to change that. That again, you have to kind of grapple with here. My favorite is to begin building up some kind of cash outside of the 401k and the retirement accounts here. I like the paying down the mortgage. Mindy disagrees on that front because paying down the mortgage has such a drastic reduction in cash outflows for the next X amount of years, in many cases two decades or more, which some of the best years of your life where you're gonna have the energy and time and inclination to do all the big things in a more robust way. And then I think building up investments outside the 401k or having a specific plan to access it, like the substantially equal periodic payments 72T concept here, or real estate or after tax brokerage investments are all ways to do it. And again, all comes the cost of sacrificing some of the tax advantages in those accounts.
- [30:12]
Mindy Jensen
Scott let's talk about real estate. Let's talk about how somebody can use real estate to escape the middle class trap. Somebody who doesn't have any real estate right now outside of their primary residence.
- [30:25]
Scott Trench
I think that a lot of investors are finding that the promise of buying a levered rental property, putting 20% down on a rental property, and then having eking out a cash flow and having that compound as you buy more and more and more is a false promise and is not coming true for most folks. Where you're seeing real estate really contribute to financial freedom, I believe for a lot of folks is when it's paid off. Another theme here, right with the paid off mortgage, a $500,000 duplex that produces a $20,000 cash flow, for example, that's a 4% yield or maybe let's call 30, 30,000, that'll be a 6% yield would be a better example. That's probably going to happen for the most part when that property is paid off, that same property that's supposed to produce $10,000 or three of them across there, one CAPEX item blows from one of the properties, blows that cash flow completely up and you can't really rely on it. So I think when you, when we see the folks who are posting who've actually retired and sit there and chill in the BiggerPockets forums, it's guys like Steve Vaughn or this guy today who has like 20 units and he produces 200 grand in cash flow because it's so lightly levered. He's basically paid off, almost paid off the whole thing. And so I think that's another way to think about it here is if you can just have one or two rentals alongside that stock portfolio, that's going to make a big, big difference on there if they're paid off. But it's going to be, I think you're going to be disappointed in the cash flow until you get to really low leverage or a long time goes by if you're trying to double the penny. I think a lot of the folks who bought, bought, bought, bought, bought, bought, bought, bought and continued to scale, they're not realizing the actual promise of that cash flow in a robust sense. But the guys who did the unoptimal thing and paid it off are realizing that and probably even though it's not going to build them as much wealth as an index fund portfolio and unlevered real estate play, probably enjoy freedom at a little bit earlier of a time period than our peers in the index fund portfolio, which we'll get to in a second here. What do you think about that?
- [32:32]
Mindy Jensen
I think I'd like you to explain it a little bit further with regards to. It's so difficult to buy a $500,000 property without $500,000.
- [32:42]
Scott Trench
That's right. I think the fundamental issue here is that becoming financially free is a function of spending less than you earn and investing the difference over a long time period in a portfolio that you will actually rely on to fund your lifestyle downstream. We're not getting there overnight. We have to think about what is the portfolio. If I hand you $1.5 million or $2 million in cash. The BiggerPockets money audience by and large says that their fire number is between 1.5 and $2.5 million. Use 2. $2 million as the midpoint in that. What is the portfolio that will actually enable you to sleep well at night without working a job on a $2 million asset base? That's the question that we're solving for here. And real estate for many people on bigger pockets. Money and bigger pockets is a part of that, but not the entire answer to that because of what we just discussed.
- [33:35]
Mindy Jensen
Okay. You just, just hit the nail on the head about this entire scenario. You said we're not getting there overnight. And I think that that's really important for people who find themselves in this middle class trap to realize you're not going to get out of it overnight. You didn't get into it overnight, but you need to start pivoting where your money is going, where you're investing in in order to be able to get out of it at all. The other end of that is you just work until traditional retirement age, which doesn't make you a bad person or.
- [34:12]
Scott Trench
You just keep contributing in the way you're doing it. And the problem begins to gradually ease because the house and cars and whatever begin to gradually get paid off and the asset base begins to swell so large past the point of what you need that the problems begin to gradually recede from the middle class trap. But I think in the meantime, that's where we're talking about like let's make, let's think about some other ways to do that. And I think one of the, one of the challenges that I have not been able to get around is paying the tax man seems to be a price you have to pay to actually realize the dollars after tax that you can spend on your lifestyle and after tax investments. And it's much harder that way. It feels smaller and it is smaller, but I think that it's, it's a part of the trade off we have to make.
- [34:56]
Mindy Jensen
Having a conversation with a tax tax planner can be really, really valuable to open up your eyes to different scenarios. Scott and I are going by what we know and tax, we're not tax experts. There are tax planners out there who could look at your portfolio and make suggestions based on where you are and where you want to be and the timeline to get there. Scott, how long would you say on average it would take somebody to withdraw themselves from the middle class trap and.
- [35:27]
Scott Trench
Depends on how drastic you want to. You want to be, right? If someone wants to. If someone says I want to become financially free in six months, I would tell them, sell your house, harvest the gain, probably tax free, go start a new house hack or something like that, and that will reduce your expenses dramatically. Take your proceeds and invest them in something that will produce after tax cash flow, whether that is a, a bond or a hard money note or a rental property, or depending on your risk tolerance and skill set, something else out there or buy that house, buy a new house hack that's paid off that then provides a couple thousand dollars of income from the other side or other units and that will greatly defray your living expenses. Sell your cars, pay off the car loans, buy two beaters, one or two beaters for that, begin packing all of your lunches, those types of things, and you can probably reduce your cash outlays by 30, $40,000 a year in that situation. Using our previous example, which all can go into the pot for cash accumulation. And if we add in our $35,000 because we're reallocating funds away from our 401k, we get a serious amount of incremental cash that begins piling up for this person. That choice is way easier for the 23 year old to make with nothing getting started than it is for the family with two kids. So it's unlikely that most people will take that choice in the current situation, but that is the fastest way to do it overnight. And you can really reallocate in a hurry and move that, you might be able to even quit your job and begin harvesting some of that 401k account to live a pretty good life right away. If you're willing to tolerate the house hack and the serious reduction in lifestyle that would accompany the set of moves that I just talked about. Much more likely again is don't buy new cars when the current loans on the cars pay off. Just hold them, just keep driving those cars, whatever they are. Another one just Stay put in the house, don't upgrade, don't change, don't whatever. Just let your income and the gradual career progression hopefully and a static mortgage payment, let inflation do its work on that front and stop putting theirs. Don't max out the 401k the whole way, but begin piling up some fraction that's meaningful outside of the 401. And depending on how fast you want that freedom and the optionality, you can just cut back more on those contributions to the pre tax retirement accounts or less if it's not as anxious a need for you. But I think there's so many degrees for ways to get out of this that it's really hard to have a one size fits all and it's going to be so dependent on individual circumstances. But you can't keep doing the same thing and expect more flexibility in your life. Something's got to change if you want out of this. If you feel stuck and like your wealth is not actually doing anything for you and can't do anything for you in the next five, seven, ten years.
- [38:25]
Mindy Jensen
Scott, I think our role here, our job here is to just introduce the concept of the middle class trap. Give ideas for ways to get out of it if you find yourself in there, ways to avoid it if you're not there yet and then give it because it is so personal. Your finances are different from my finances are different from Kyle. Math finances are different from everybody else's finances. So let's not even try to give advice. Although I will say that the majority of people that we have talked to have reached financial independence from a position of approximately zero net worth to financially independent in about 10 years.
- [39:06]
Scott Trench
I think that's the minimum. Yeah, I don't know very many folks who got there faster than that. But, but that's, that seems to be the minimum. Yeah.
- [39:12]
Mindy Jensen
So since you're already in a position of you're saving, you're investing, you, you know, you have your house and whatever. Even if you don't have a house you still like. You could be in the middle class trap when all of your money is in your pre tax 401k because you're already used to this, I think your trajectory will be or your timeline will be much shorter than that, 10 years to get yourself out of the middle class trap because you're not planning for all retirement. You're planning for the portion of time from early retirement, whatever age that is to 59 and a half, 55 if you have the, if your plan allows to, when you can access those retirement funds earlier than 65. All right, Scott, should we get out of here?
- [39:55]
Scott Trench
Let's do it.
- [39:56]
Mindy Jensen
I would love to hear from my listeners. What are you doing with your portfolio? How are are you in the middle class trap? And if you are, how are you getting out of it? Email me mindy biggerpockets.com email scott scott biggerpockets.com or post in our Facebook group because we will have a thread for this particular episode. If you would like to share publicly again, please go over to our YouTube channel if you are not already a subscriber. We are trying to get to a hundred thousand subscribers because then Scott gets a beautiful plaque for his little bookshelf behind him that says we have a hundred thousand subscribers. So Please go to YouTube.com biggerpocketsmoney and click SUBSCRIBEES. Thank you, thank you, thank you for listening. We really, really appreciate you and you spending your time with us. But that wraps up this episode of the Bigger Pockets Money podcast. He is Scott Trench. I am Mindy Jensen and I am going to shout out to my fans Lucy and Juliet and say, take care, Brown Bear.