Here’s the question: How to invest $250K if you want to set yourself up for long-term financial freedom and eventual retirement? Are you better off investing that money in stocks or in real estate like single-family homes and duplexes?
In this article, we’ll examine the pros and cons of both, by considering four factors: Risk, Returns, Liquidity and Time Commitment.
(Spoiler Alert: There’s a place for both in your portfolio.)
4 Factors To Consider When Choosing How To Invest $250K
Factor #1 - Risk
Advantage: Real Estate
Stock market investors often confuse volatility with risk. The daily gyrations of the stock market make them uneasy, and that feels like risk, but really isn’t – it’s just volatility.
The true definition of risk is the potential for a permanent loss of capital. The stock market will go up and down as it pleases, but it’s the permanent loss of capital that you as an investor should focus on.
Using that definition, real estate has the edge over stocks. As we’ve seen in the last year, even bellwether stocks like Amazon and Google can decline by 40% – and stay there. In the past, some stocks have even lost all their value, going down to zero!
That doesn’t happen with real estate, which is one of the reasons it’s a good place to invest $250K.A single-family home is a real (not paper) asset, a building with economic value for which there is a demand. How many single-family homes lose 40% of their value in one year? While home prices may decline during soft markets, in the long run, real estate almost always goes up and can serve as a stabilizing force in your portfolio during times of stock market turbulence.
Consider this: Real estate is so safe that banks are willing to lend you 75% of the capital required to purchase a property, requiring you to put only 25% down. And insurance companies are willing to insure your property to cover all losses – even if the property burns to the ground.
Why won’t they do that for your stock portfolio?
What does it tell you when someone who lends money for living won’t lend you 75% of the money you need to buy stocks – because it’s too risky? What does it tell you when someone who sells insurance for a living won’t insure your stock portfolio – because it’s too risky? Is that where the bulk of your life savings and retirement nest egg should be?
When considering the potential for a permanent loss of capital, especially when investing large sums of money like $250,000, real estate is the safer bet.
Factor #2 - Returns
Advantage: Real Estate
For our purposes, I’m defining “returns” as the compounded rate of return over the life of the asset i.e., 30 years for an investment property vs. 30 years in the stock market.
Historically, the stock market (measured by the S&P 500) has returned 7.0% per year on average, while residential real estate – nationwide – has returned 4.0% per year on average. But that comparison overlooks two important factors:
1) Many growth markets appreciate much higher than the national average
By picking metros with exceptional job and population growth where the demand for housing is outstripping supply, you can achieve returns far above the national average. When considering how to invest $250K, buy in Dallas, not Toledo.
Of course, you could claim the same for the stock market if you can pick stocks like Warren Buffett. But for most of us, it’s a lot easier to pick a winning real estate market than to pick winning stocks consistently.
2) The Power of Leverage
Investing your $250,000 in stocks will get you a $250,000 stock portfolio. Investing that same $250,000 in real estate will get you a $1,000,000 real estate portfolio – such as four new-construction homes in growing metros like Dallas or Orlando. This is because with real estate, you can put down 25% and have the bank finance the other 75%. A $1,000,000 portfolio growing at even the conservative 4.0% rate of return will outperform a $250,000 portfolio growing at a 7.0% return.
Here are the numbers:
For equity growth:
At 7.0% per year, your $250,000 stock portfolio will grow to $1.9 million after 30 years and, after paying 15% capital gains tax, you’d net $1.6 million.
At 4.0% per year, your $1,000,000 real estate portfolio will grow to $3.2 million after 30 years and, since your tenants will have paid off the mortgage debt for you, you’ll own that $3.2 million portfolio free-and-clear with 100% equity. Not only that, but you can also avoid capital gains taxes by using a 1031 exchange to buy more properties with higher rates of return.
For cash flow:
Cash flow depends a lot on whether you buy dividend stocks or growth stocks, but whatever dividend payments you receive will be taxed. The cash flow from real estate is mostly sheltered by mortgage interest write-offs and depreciation write-offs.
All said, leveraged real estate’s total returns from cash flow, appreciation, loan paydown, and tax write-offs are hard to beat. This is why it’s one of the best places to invest your $250,000.
Factor #3 - Liquidity
By “liquidity” I’m referring to the ease with which an asset can be converted into cash and the efficiency of doing so with minimal loss of capital.
On this metric, the clear winner is stocks. A stock market investor can go online 24/7 and liquidate his or her position in minutes, paying at most a small transaction fee.
Liquidating real estate on the other hand, requires a lengthy process of making the property ready for sale, scheduling inspections and appraisals, hiring an agent, listing, and selling the property – a process that can take months. Also, the closing costs can eat up five percent or more of the sales price. (These high transaction costs are one reason many investors prefer a buy-and-hold strategy.)
For the liquid part of your portfolio, stocks are the clear winner.
Factor #4 - Time Commitment
How much time will you have to commit for either of these investment types? That will vary depending on how you invest the $250K.
For stocks, you could have your portfolio in individual stocks that require monitoring – especially at inflection points in the economy. When the market is going up, you may not have to spend much time tracking your portfolio, but if interest rates spike or there is war in Ukraine or there’s disruption to supply chains or there’s a pandemic, your stocks could crash if you don’t follow them closely day-to-day. On the other hand, you could invest in a passive S&P 500 ETF and not worry about it. So, stocks can take up as much or as little time as you’re willing to commit to.
Real estate is usually passive, as you’ll have a property management company that takes care of the day-to-day maintenance requests, processes the rents and wires money to your bank account every month.
The most time-consuming part of real estate investing comes when you buy and when you sell. Buying entails identifying a market, deciding what property to buy, sending your lender two years’ worth of tax returns and W-2s to qualify for the loan, reading the inspection reports and signing all the closing documents. Selling involves getting the property ready for sale and finding an agent who can list and sell the property for you.
Once purchased, the ongoing demands on your time are minimal. You have to upgrade the property after a tenant leaves and work with your property manager to find a new tenant. Other times, something will need to be repaired or replaced, and your property manager will need your approval to spend the money. But these events typically don’t take much time.
Overall, while the time commitment ebbs and flows for both asset classes over the life of the asset, real estate is usually more time-consuming.
So, should you invest your $250,000 in stocks or in real estate?
As mentioned earlier, it’s not either-or. Since stocks and real estate are uncorrelated to each other, they are complementary asset classes that have a place in your diversified portfolio. As we have seen, real estate offers higher returns with less risk, provided you’re willing to tie up some of your assets for a longer time frame. I therefore recommend a real estate-heavy allocation.
Scenario 1: You have more than $250K to invest and you’d like to diversify
If you’re like most people and already have stocks in a 401(k) or IRA plan, then to diversify you might want to put that $250K into real estate. With a 25% down payment, your $250K would get you a million-dollar portfolio consisting of four brand-new, low-maintenance homes in growing metros. A million-dollar portfolio in a growth market will likely double in value in 10-12 years, which alone will add $1M to your net worth, not counting principal paydown.
I know a lot of investors who bought rental properties 10-12 years ago. Are they happy? No!
Every one of them says “I should have bought more”.
Scenario 2: $250K represents all of your investable assets
On the other hand, if that $250K represents your entire investable assets, then you might want to put some into stocks and some into real estate, for example $100K in stocks and $150K in real estate. Personally, I put my IRA funds into stocks and my non-IRA funds into real estate, and that allocation seems to work well. In my case, that works out to about a 50-50 split for each asset, and I’m comfortable with that. Your mileage may vary.
The Bottom Line
To maximize long-term wealth and diversification while minimizing your risk, you can’t NOT have some of your assets in real estate. Dip your toe in the water by buying one property, preferably a new construction (i.e., low maintenance) single-family home in a metro with job and population growth and see how it goes. After a few months, if you’re happy with the results, it’ll be easy to add to your portfolio since you’ve already done the market research and due diligence. Lather, rinse, repeat.
To learn more about investing $250K in real estate, talk to one of our experienced real estate investment counselors who can show you what a real estate portfolio would look like for you. For a free consultation, become a member of RealWealth today for free.