Investing is an age-old strategy to make sure that at some point in life you can relax, travel, and enjoy your hard-earned retirement years. By investing early and continuing to do so a little each month. Your initial investment will grow over the long term and the idea is that you’ll eventually be able to live on just the interest that large principal amount generates.
There are several tactics to growing your wealth through investing. The most common is by investing in the stock market through an employer-sponsored 401(k). You can also invest in stocks on your own, which means you’re able to access those funds at any time — as opposed to a retirement account where you must reach a certain age to withdraw funds penalty-free.
Investing in real estate is another way many investors grow their wealth. And since there’s no restrictions on how you use any profit you generate from it, this tactic may even allow you to retire early.
Let’s dive into the pros and cons of both real estate investing and stocks.
Real estate pros
Relatively safe strategy
When you “buy and hold ” rental property, you’re investing in a relatively safe strategy. Real estate doesn’t tend to have large fluctuations in value. Instead, it has historically increased slowly over time. Plus, in any economy — whether it be an economic boom, recession or depression — people need a place to live. While market rents may vary, there will always be a need for affordable rental housing.
Immediate cash flow and passive income
Real estate investing can be as hands on or as hands off as you make it. You may generate more monthly cash flow by managing your properties yourself and doing repairs on your own. If you still have a busy day job or simply don’t want to deal with it, you can also pay a property management company to handle all that for you, while still maintaining ownership of the property.
By having positive cash flow, your tenants essentially pay all the bills, including your monthly mortgage payment. This means you’re building equity without having to contribute any of your own money on a monthly basis.
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As inflation occurs, if your money is not growing, it’s actually losing value. Inflation is around 2.5% each year, meaning you can currently purchase 2.5% less with your dollar than you could have a year ago. Your investments should grow more than this percentage in order to keep up with inflation and actually result in growth.
Since home values typically increase 3% to 5% per year, according to Zillow, putting your money in real estate can buffer the effects of inflation. Not to mention that rent values tend to mimic the inflation rate. Add these to your monthly cash flow and you’re not only beating inflation, but making a decent return on your investment.
Real estate allows you to generate interest on borrowed money in the form of a mortgage. While you don’t need to have the full amount of the home’s value invested on your own, you get to realize the full return — be that monthly rents, or property appreciation.
If you’ve ever heard that investing in real estate is great for your tax deductions, it’s true. The IRS allows you to deduct expenses like owner-paid utilities for your properties, mileage, and portions of bills related to your business, like for your cell phone or internet service.
On top of that, you can depreciate your property. When depreciating, you can allocate the cost of your property over its useful life, thus reducing its taxable income. Perhaps one of the biggest tax benefits to real estate investing is that — unlike other entrepreneurial businesses — profit from rental property is taxed as ordinary income and not subject to self-employment tax, which would be a whopping 15%, in addition to your normal income tax rate.
Real estate cons
Time and energy
While you may be able to outsource the management of your real estate property, you’ll still spend some time and energy purchasing the property, fixing any needed maintenance issues, and setting up the workflow. Plus, you’ll have to put in some time during tax season.
Real estate isn’t liquid
When you tie your money up in properties, it can be difficult to access. If you need to sell in a pinch, you could end up selling for less and still having to wait 30-60 days before you have access to the money.
Money can become tied up in equity in a bad market (i.e. 2008 real estate market crash)
Real estate generally increases in value over the long term, but it does have its down swings. If you’re not looking at investing long term and you don’t have much equity built up, it could catch you off guard. This happened during the real estate market crash of 2008. Many investors were “under water,” meaning the value of the properties they owned dropped below what they still owed on the mortgage.
They were either forced to keep the property — even if it wasn’t generating a profit — or sell quickly and have to pay with money out of their pocket to pay back the bank for the mortgage.
Real estate tends to outpace inflation, but not by much
As mentioned in the pros above, real estate tends to outpace inflation, but not by much. If you’re investing in real estate simply for appreciation, you’d likely be better off in the stock market, with an average return of 10%. But, if you’re returning a positive monthly cash flow, your rentals may still be a good move.
The costs of selling real estate
While you can move money in and out of the stock market with ease and little expense, real estate can be a bit more difficult, especially if you’re selling. Closing costs for sellers average 5% to 6% of the final selling price. On a $100,000 investment property, that’s $5,000 to $6,000.
If you are selling, consider working with a discount agent to save on commissions. Also, keep in mind how you may be able to avoid paying capital gains on your sold investment property by using the 1031 exchange.
Gains over time
Historically, stocks have increased in value over time. The S&P 500 averages 9% to 10% ROI annually. While this isn’t true every year, over the long haul stocks should increase in value.
Own part of a business with no work required
When you own stocks, you essentially own a portion of a company, but don’t have to do any work for them to turn a profit. You simply allow them the use of your invested money and realize a return on that money if the company does well. Stocks are the most passive investment vessel you can find.
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You can own as many different stocks as you desire and even a portion of a share. This allows for easy diversification among both industries and companies. You can even diversify how risky your portfolio is. When investing in real estate, you must own the entire property — unless you’re investing via real estate investment trusts (REITs)— and would need much more money to diversify in the same way as the stock market.
Stocks are very liquid when compared to real estate. In fact, most trading platforms allow you to move money to your banking account with the click of a button. This can be helpful if you think you may need to access the funds at a later date, but what to put them to use for the near future.
Economic downturns can cause major loss
While over the long term, stocks generally increase in value, there may be periods of economic downturn in which your stocks lose a huge amount of value within a couple hours. And while it may be your first instinct to panic and pull out the rest of your money, it’s best to remain unemotional and detached from your investment during this time. The market will usually correct itself after a period of time and your investments will increase again.
This has never been more relevant than the crashes we’ve seen in the past few weeks from COVID-19. In times like these, real estate appears to be the more stable option for investors, although it comes with its own challenges if we dip into a recession.
Stock prices fluctuate frequently
Unlike real estate, stock values change by the minute. While you may be able to get ahead of a slowly falling real estate market, stocks can be a bit more tricky. Plus, they may go up again soon so it's not always a good idea to pull out your money in panic.
While you may be able to increase your wealth some by investing in the long term, trying to make a large profit through stocks can be difficult. You can buy into riskier stocks in the hopes that they pan out. But, remember that you have no say in the company so you can’t have any effect on its trajectory. This in and of itself makes stocks risky — profit and loss is out of your hands.
If you’re wanting to play the short term game, you’ll need to pay close attention to the market to know when to buy in and when to pull out funds. But, if you’re playing the long term, you’ll need to be okay with sitting on the sidelines and letting the market go one without any capacity to change it.
In both types of investments, it’s imperative that you do your research, so no matter what, don't go in blind.
Author Bio: Luke Babich is the CSO of Clever Real Estate, the online referral service that connects home buyers and sellers with top-rated agents. Luke is a real estate investor in St. Louis, MO with over 24 units who specializes in multifamily units. His first investment was a house hack with Clever's cofounder, Ben Mizes.