- The stock market vs real estate debate is a legitimate discussion that must be had by those looking to build long-term wealth.
- Determining whether to invest in real estate or stock market equities will depend on your own goals.
- There are a number of reasons to buy stock in a sound company, but real estate may come with more benefits.
There are a number of investment vehicles that have become synonymous with a good rate of return. Participating in the real estate industry and stock market, in particular, represents two of the most popular wealth-building strategies known to today’s investors. Both have developed a reputation for awarding savvy entrepreneurs with attractive returns; so much so, in fact, that both deserve a spot in one’s retirement portfolio.
Historically, both of these investment strategies have rewarded those who mind due diligence and educate themselves on current best practices, which begs the question: When you compare real estate vs stock market investing, which is the better wealth-building vehicle? Should those looking to build long-term wealth invest in real estate or stocks? Continue reading to help decide which strategy may be right for you.
Stock Market Vs Rental Property
Today’s best investment portfolios are diversified enough to mitigate one’s exposure to risk. A properly diversified investment portfolio will typically boast several investment vehicles, not the least of which include stocks and rental properties. Both stocks and rental properties have proven they belong in an investor’s long-term wealth-building plans. However, there are several differences between the two that warrant your attention. In order to finally settle the real estate vs stock market debate, be sure to carefully consider each of the following points:
- Control: Those interested in investing in stocks will quickly learn that there is very little control one may exercise in the stock market. As is the case with every single stock on major indices, investors can’t dictate anything other than how much they choose to invest in a company. The stock’s performance is determined entirely by the company and how it decides to do business. Rental properties, on the other hand, award investors considerably more control over the asset’s performance. Rental property owners have control over everything from the location and quality of the asset to the marketing and cash flow.
- Asset Tangibility: Investing in the stock market won’t result in any tangible assets. When you purchase a stock, you are buying into a particular company. However, the stock you now hold isn’t tangible; you can’t do anything with a stock other than hold onto it. Real estate, on the other hand, is entirely tangible; your investments are secured by a physical asset.
- Cash Flow: In the event the stock market takes a downturn, there’s a good chance your stocks will take an immediate loss. Of course, those losses aren’t realized until you sell, but the value of an individual stock is subject to the ebbs and flows of a traditional marketplace. In the rental property industry, an economic downturn doesn’t necessarily spell trouble for passive income investors. More often than not, history teaches us that rental properties continue to produce monthly cash flow, even with the market dips. On top of that, rental property owners have likely already managed to build up equity in a home, which acts as an automatic savings account.
- Leverage: Investing in the stock market requires investors to use the cash they currently have on hand. In other words, if you only have $100, you may only invest up to $100. However, those buying real estate may leverage other people’s money. Rental property investors may leverage funds from other sources to acquire properties that are worth more than the amount of available funds they currently have. A $20,000 loan may allow an investor to acquire a $100,000 property, essentially maximizing one’s cash-on-cash return.
- Liquidity: Stocks tend to grant investors more liquidity, as it’s almost always simpler to sell off stocks when necessary than to sell a home. Real estate, while relatively liquid, takes a lot longer to realize a sale.
- Tax Advantages Investors that realize gains in the stock market will need to pay taxes on the money they earn, whereas rental properties offer investors a significant tax shelter. Rental properties provide opportunities for multiple tax advantages such as depreciation, deductions and a 1031 Exchange.
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Reasons To Buy Stock
Stocks are ubiquitous with many of today’s best retirement strategies. The 401(k), in particular, is perhaps the most common way most people save for the future, and for good reason. Among the benefits of investing in stocks listed below, perhaps the biggest one is diversification. Review the following reasons why stock investing is important for investors to consider:
- Track Record: Stocks have historically done well for those with the patience to ride out the ups and downs of a market. More specifically, the S&P 500 has demonstrated a propensity for returns over the long run. From 1930 to 2013, the annualized percentage return in the S&P 500 was 9.7%. There were only a couple of decades in that timespan (1930-1939 and 2000 to 2009) where returns were negative, and even then they were minimal losses.
- Passive Results: Investing in stocks can be as passive or as active as you like. There are those that are perfectly comfortable spending every waking hour studying the stock market, but for investors looking for a more passive stream of income, stocks can generate incredibly passive returns. There are professional managers who will manage your own portfolio of stocks for you. That way, you may benefit from their results without actually putting in much work yourself.
- Reinvesting Dividends: High-quality stocks tend to increase their profits every year, which means their dividends increase, too. In the event you invest in a quality stock that pays out dividends, there’s a good chance your checks will increase each year in proportion to the company’s success. Not only that, but those that reinvest their dividends could benefit from compound growth. As Fortune magazine is quick to point out, “If you’d bought a single share [of Johnson & Johnson] when the company went public in 1944 at its IPO price of $37.50 and had reinvested the dividends, you’d now have a bit over $900,000, a stunning annual return of 17.1%.”
- Diversification: Diversifying your holdings in the stock market is often as simple as buying and selling stocks. With the click of a mouse or swipe in an app, investors can acquire stocks in several different industries as a means of diversification.
- Liquidity: Stocks allow investors to maintain a very liquid position. Over the course of market hours, investors may buy and sell as they choose to. It is entirely possible to sell your entire position, many times over, in a single day. As a result, gaining access to your funds is as simple as selling as many shares as necessary.
Risks Of Buying Stock
As with any investment, there are two sides to every coin. While the benefits of the stock market are well documented, so too are the risks. Below you will find some of the most common risks associated with investing in the stock market:
- They Require Patience & Discipline: While stocks are susceptible to ups and downs, history has proven that patience pays off. Over time, stocks, as measured by the Standard & Poor’s 500 index, return about 10% annually. However, those types of returns are rarely realized in the hands of inexperienced and inpatient investors. Those without the ability to hold on in tough times could find stocks to be a major drain on their wealth-building endeavors.
- Short-Term Fluctuations: Stocks are extremely susceptible to short-term fluctuations that can make even seasoned investors question their viability. In as little as a single day’s time, it is possible for a $50 stock to soar as high as $80 or as low as $10. Those who aren’t prepared to deal with the volatility could find themselves questioning their own strategies.
Reasons To Invest In Real Estate
While investing in stocks has its pros and cons, so too does investing in real estate. You may find, however, that the pros significantly outweigh the cons. Review the benefits of real estate investing below:
- Invest In Something Tangible: Investing in real estate results in a tangible asset. Not only can you look at the property you just bought, but you can also feel it and walk through it whenever you like. While that may not seem like much of a reason to invest in real estate, procuring something tangible is psychologically beneficial to many, and may actually aid in understanding exactly what you are investing in. At the very least, there’s something to be said about investing in a physical asset.
- Familiarity: Many people already have an inherent familiarity with real estate before they even invest their first dollar. Whether it has to do with growing up in a home or visiting properties frequently, almost everyone is familiar with the concept of real estate investing and how it works. That said, even the slightest familiarity with real estate can aid in one’s comprehension of the entire investing industry.
- Leverage: Real estate can be purchased using other people’s money. In fact, most people borrow money from banks to acquire their own homes. As a result, real estate investors have the ability to maximize their cash-on-cash return, perhaps more than anyone in any other industry. You see, when you can use someone else’s money to purchase a property, your own funds are never depleted and access to more money is just another loan away. Perhaps even more importantly, however, is the ability to acquire multiple properties at once. Using leverage, borrowers can buy multiple homes using a down payment and still realize the returns the industry has become synonymous with. It is entirely possible to purchase a $500,000 property with $100,000.
- Hedge Against Inflation: Rental properties, in particular, have served as a reliable hedge against inflation for quite some time. Unlike almost every other form of investment, real estate reacts proportionately to inflation. As inflation increases, so too do rents and home values.
- Build Equity: In the event you borrow money to complete a real estate deal, you will be required to pay it back with interest. However, each payment also gets you one step closer to paying down your principal payments. You are simultaneously building equity and wealth in the same property.
- Tax Shelter: Taxes remain one of the greatest benefits of investing in real estate. Rental houses, apartments, vacant land, commercial buildings, industrial, shopping centers and warehouses all offer their own variation of tax incentives, most of which act as a tax shelter for one’s income. Rental property depreciation and the mortgage interest deduction, for example, are both ways to save a lot of money come tax time.
- Cash Flow: Real estate remains, to this day, one of the most proven wealth-building strategies for investors. According to Investopedia, the average 10-year return for residential and diversified real estate investments are about 7.5%.
Risks Of Investing In Real Estate
There isn’t a single investment vehicle that doesn’t come complete with risks of its own, and real estate is no exception. That said, it’s up to you to weigh the risks and rewards of real estate investing, and determine if it is worth your while. Here are some of the most common risks to weigh against the positives already discussed:
- Requires More Involvement: Unlike stocks, real estate investing will require more hands-on work. Whereas stocks will require their own due diligence, real estate is a lot more involved. The success or failure of an investment is often directly correlated to ones involvement; you get out of it what you put into it. It’s important to note that depending on your type of investment, passive or active, you can choose how involved you want to be.
- Vacancies: Rental properties are often a great cash-flowing vehicle for building wealth, but only if they have tenants. In the event a rental property sits vacant, property owners are responsible for paying the mortgage, which will cut into their bottom line. Additionally, homeowners are still responsible for paying taxes, maintenance, utilities, insurance, and more even if the home is unoccupied. Smart investors will save a percentage of their property’s cash flow to account for these costs ahead of time.
- Depreciation: The housing market is cyclical, which means home prices are constantly fluctuating. Provided you are trying to sell a home, the same cycle everyone else is impacted by could either hurt or help your chances of making money. In the event you need to sell a property to gain liquidity, you may not make as much as you had hoped for.
It is always important for investors to diversify their portfolios in an attempt to mitigate risk and maximize their rewards. A combination of investments (including real estate and stocks), as it turns out, offers investors a great way to do just that. Therefore, the real estate vs stock market debate isn’t really a debate at all, but rather a conversation each and every investor should have with themselves. In doing so, investors should weigh the pros and cons of real estate vs stocks to choose the strategy that helps them meet their own goals.
Is your own portfolio diversified between several different investment vehicles? Which asset class do you wish you had more of? Please feel free to let us know in the comments below: