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Stock Market Vs Real Estate: How to Make Your Money Work For You

Stock market vs real estate

Rich Fettke


Summary: In this article, we go over the pros and cons of investing in the stock market vs. real estate, market trends over the last three decades, and why Opportunity Zones are drawing people away from the stock market and into real estate.

New and experienced investors continue to ask the age-old question: Should I invest my money in the stock market or real estate? In this article, we analyze the pros and cons of each, what we can learn from past market trends and why investing long-term is the most important investment strategy regardless of where you decide to put your money.

Pros & Cons of Investing in Stocks

Buying a stock essentially means you are buying ownership in the company. If the company does well, you profit. If it doesn’t, there’s a chance you’ll lose your invested money. According to the S&P 500, the stock market had an average return of 10.31% from 1970 to 2016. This percentage serves as a benchmark for U.S. stocks only. A long-term investment approach, with a diverse portfolio, will lower risk and increase your potential return on investment. Remember, investing in the stock market is a marathon, not a sprint. Don’t panic when certain stocks decline. Staying in it for the long haul will eventually pay off. Let’s talk about the pros of investing in stocks first.

Pro #1: Less Hands On = Less Work

Investing in the stock market can be easy. It demands less time than other types of passive investing, doesn’t require a lot of knowledge or expertise, and little to no management on your end. If you like the idea of someone else, like an investment expert or firm, managing your stock market portfolio, this may be the route for you. Financial advisors will put your money into funds based on several factors, including, age, income, retirement goals, etc. Not having to spend extra time or worry about the details of which stocks to invest in and for how long, is an appealing route for many new investors.

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Pro #2: Flexible to Move, Lower Transaction Costs & Fees

Want to get out of or trade a stock? Transaction costs online are less that $5 and monies can be moved almost instantaneously to different funds.

Stocks are quick and easy to move or sell. They provide flexibility to reallocate your money, into a tax-free retirement fund, for example.

Pro #3: More Diversification Than Real Estate

With the stock market, not only can you invest in different companies, you can invest in different business sectors. This is called diversifying your portfolio and will greatly decrease your risk. If one sector declines, and another rises, you’ll likely make up any money lost on a underperforming stock. Use the knowledge and experience of a wealth advisor to create a diversified portfolio and lower the risk of losing the money you invest.

Mutual funds are the most common type of passive investments. On average, a return of 10% is expected, however there are several funds that average or exceed a 12% return. Again, utilizing an investing professional can help find the right mix of mutual funds to invest in.

Pro #4: Buy Stocks in Products You Like or Use

Investing in the stock market can also be fun! Excited about a certain product or something you use everyday? You can buy stock in a company or product you’re passionate about, and profit from its success. However, choosing where to invest your money can turn into an emotional decision, instead of a logical one. Do your due diligence and consult with an expert to ensure its a smart investment with a greater return versus risk.

Pro #5: Greater Potential for Quicker Return (And Greater Risk for Loss)

Stocks have proven to outperform other passive investments, like real estate, in the short run. You could see a return on investment within a year, whereas real estate tends to grow (or decline) over longer periods of time. However, “predicting” the stock market is nearly impossible and there is always risk involved with any investment. While there is greater potential for a quicker ROI, it’s also important to account for the risk involved. More on that later…

Pro #6: More Liquid Assets

Another benefit to investing in the stock market, is that you can get out with a click of a button. Don’t like how your investment is performing? Simply pull your money out and invest in a different stock or back into savings.

Now that we’ve covered the pros of investing in the stock market, let’s go over the cons…

Con #1: You’re at the Mercy of the Fund & How It’s Managed

While some investors like not having control or management responsibilities over their investments, because it saves time, others see this as a disadvantage. The risk here is, if a fund is poorly managed, there’s not much you can do about it. Unless you spend a significant amount of time researching and educating yourself on the intricacies of specific funds, (which negates the advantage of using an expert to save time and energy), lack of control may be reason enough to invest your money in other passive investments.

Con #2: Not a Tangible Asset

While an advantage of stocks is that they are liquid, a disadvantage is that they are not a tangible asset. Meaning, if your money is in a stock that suddenly plummets, you could be left with nothing. With a tangible asset, like real estate, even if the market drops, you still own a tangible asset, with built-in equity, and all your invested money won’t be lost.

Con #3: Higher Risk If the Stock Market Drops, Your Profits are Lost

The stock market can be volatile at times. Sudden changes in the economy can impact entire sectors or companies. If there is an unexpected drop, your money could be lost instantly. On the one hand, passive investors can take more risk and potentially make a lot of money in short period of time. On the other hand, the risk of losing a lot of money is also greater. High risk stocks going bad often account for many investors facing financial crises, and even bankruptcy.

Con #4: You Pay Taxes on Any Profits When You Sell

Let’s say you invest $20,000 in a stock and over time is now worth $100,000. You are required to pay taxes on the money you’ve made, in this case $80,000, when you decide to sell your shares. How much money you pay on capital gains depends entirely on how long you hold onto your shares. Short-term and long-term gains are taxed very differently by the IRS.

Short-term gains (investments held for less than a year) are taxed as “ordinary income” and must be applied to your taxable income for the year. How much money you make annually will place you in a certain tax bracket, and give you an idea of how much you’ll be taxed on capital gains. For example, if you make $65,000/year individually, you are expected to pay taxes on 22% of your income ($7,599). Avoid paying a high tax rate with long-term gains.

Long-term gains (investments held for more than a year), have a substantially reduced tax rate. This is to encourage investors to buy and hold on to stocks for a longer period of time. For example, if your annual salary is below $38,600, you fall into the 0% capital gains tax bracket. Individual filers earning between $38,601 and $425,800 annually, will be taxed 15% on capital gains. Because long-term gains have such a reduced tax rate, it’s easy to see the importance of holding onto investments long-term.

Pros & Cons of Investing in Real Estate

Next, we’ll talk about investing in real estate vs stocks. Just like any investment, your risk versus expected returns should be carefully assessed when purchasing real estate. Let’s discuss pros first…

Pro #1: Your Monies are Secured by a Physical Asset

Unlike the stock market, purchasing real estate has the advantage of owning a physical asset. Holding onto a physical asset or property allows it to appreciate (increase in value) over time. If you are buying a rental property, you can leverage your investment and maximize your cash return – meaning you can invest with less money down. For example, if you invest $75,000 in real estate, you can qualify to buy a property worth four times that amount. With home values rapidly rising, investors are enjoying higher appreciation rates.

Pro #2: Higher Appreciation Potential

Just like stocks, investors are encouraged to hold onto a real estate property long-term. However, the advantage of investing in a physical asset, like a rental property, is its ability to appreciate over time. Even with the ups and downs of the real estate market, there is really no comparison for the appreciation potential of a tangible asset.

Pro #3: Protection from Inflation

Home and rental prices tend to rise with inflation. Purchasing real estate offers risk protection as your mortgage payments do not increase with inflation. As home values and rental rates increase, your mortgage remains the same, which is allows for greater monthly profit potential. Your investment doesn’t depend on the highs and lows of stock market. While this is an advantage for real estate investors, it’s still vitally important to perform due diligence and run the numbers before deciding where, when, and how to purchase a property that ensures a decent ROI.

Pro #4: More Control Over Your Investment

Private lending offers much more control over your investments. You get to decide, who you invest with, length of investment, and rate of return. If you are purchasing a rental property, you are in control of what and where you buy, along with any improvements that will increase value or rental rates. You get to decide which expenses your tenants will pay and have a better idea of how much monthly cash flow to expect (another advantage we’ll discuss next).

Pro #5: You Can Still Generate Cash Flow in an Economic Downturn

One of the biggest advantages of buying real estate is when the stock market drops, your profits aren’t instantly lost. With some private lenders, there is up to 50% equity already built in to your property, so you won’t risk losing your entire investment. Additionally, if you own a rental property, you’ll still be collecting consistent monthly cash flow from your tenants, regardless of stock market fluctuations (2).

Pro #6: Multiple Tax Advantages Including: Depreciations, Deductions, & 1031 Exchange

The key here is understanding the many tax deductions a property owner can take advantage of. Many landlords simply have no idea they could be saving thousands of dollars a year on eligible tax deductions related to their property. Qualifying tax deductions include, interest, depreciation (loss of value over time aka wear and tear), and property expenses (repairs, maintenance, insurance, furnishings, etc.). More information regarding specific rental property tax benefits can be found in an upcoming article.

What is a 1031 Exchange? Basically, it allows investors to “defer” paying capital gains taxes when selling an investment property, by using the profit gained from sale to purchase another “like-kind property.” How much can real estate investors save by utilizing a 1031 Exchange? Investors can expect roughly one third of capital gains to go toward taxes, instead of their entire profit. Keep in mind the process of a 1031 Exchange can be complicated, which is why most investors seek professional help to ensure nothing falls through the cracks.

If you want to learn more about 1031 Exchanges, a more detailed breakdown can be found in our article, How To Do a 1031 Exchange: Rules & Definitions for Investors 2018 and webinar, Section 1031 Exchange Basics: How to Avoid Capital Gains Tax.

Con #1: Selling Property May Take Longer Than Anticipated

One drawback to owning real estate is that it’s illiquid. Meaning, your invested money could be tied up for months until you’re able to sell your property. If you are thinking of selling your property, keep in mind that timing is key and it may be worth waiting for a rise in the market when homes or rental properties are in high demand. Although not as exciting or fast, RealWealth focuses on long-term investment strategies (usually about 10 years), because it is far more profitable. Our greatest asset in long-term investing is time. The longer you can hold onto a property (assuming it’s a wise investment from the start), the more money you’ll make.

Con #2: More Real Estate Commissions & Fees

When you decide to sell your investment property, closing costs, commissions, fees and taxes can add up and drastically decrease your ROI. Do the math and if selling your property doesn’t produce a positive return, consider holding onto the property until it does.

Con #3: More Hands-On = More Work & Time (i.e. Maintenance, Tenants, Vacancy, etc.)

There’s no question that owning real estate or a rental property requires more hands-on work and time. Keeping up with maintenance demands, finding quality tenants and accounting for months of potential vacancy, all add time and often stress to property owners. If you don’t have the time (or desire) to do hands-on work or deal with tenants, other investment opportunities may better suit your lifestyle.

Real Estate vs. Stock Market Returns

As we compare real estate to stock market returns, it’s important to keep in mind that these are two very different investment types. Historically, stocks have outperformed real estate over the past few decades. However, stocks tend to be more unpredictable and it’s possible to lose your entire investment. Whereas, home values tend to increase steadily over longer periods of time. Regardless of where you invest your money, there is always risk involved and no guarantee for return.

Average Stock Market Return in the Last 10 Years

According to the S&P 500, stocks have gone up 93% since March 2007. Stocks have been steadily on the rise with a 273% increase, since the stock market dropped in 2009. Don’t get excited just yet – if we look at average stock market returns year over year, the numbers aren’t as impressive. In 2013, the average annual return was 32.43%. In 2014, 13.81% and in 2015, 1.31%.

In the Last 27 Years, the Stock Market Has Outperformed Real Estate

From 1991 to 2016, the stock market has cumulatively outperformed real estate 700% to 164%, respectively, even with the stock market crash in the 2000s. Having said that, timing matters in both stock and real estate markets. From 2000-2009, amidst a terrorist attack and recession, the S&P reported an average return of -1%. This period of time is known as the “lost decade”. While times were tough and millions of Americans lost or got out of all stock investments, this is only part of the story. In the 10 years before the 2000 stock market crash, the average return was a healthy 18%. Once again emphasizing the importance of investing long-term.

Timing Matters – Since 2000, Real Estate Has Outperformed the Stock Market

According to the Federal Housing Finance Agency, housing prices are up 85% while stocks are up 79% (as of 2016), since September 2000. Location also matters, with highly populated metropolitan areas experiencing huge increases in home values over the last decade.

What is a good return on real estate investment and what can we expect in the future? Our expectations on how both markets will behave can only be predicted by how they’ve performed in the past. A real estate vs stock market graph, clearly illustrates long-term trends for each market and is an excellent resource for predicting when and where to invest your money. For a side-by-side comparison of investing in both the stock market and real estate market, check out this chart we put together.

New Real Estate Opportunities That Might Appeal to Stock Market Investors: Opportunity Zones

What is an Opportunity Zone?

Opportunity Zones or “Ozones”, are low-income areas in the U.S. that are falling behind more affluent communities. Local governments from each state have designated 25% of these low-income census tracts as Opportunity Zones, in an effort to promote investing in these areas.

To qualify as an Opportunity Zone, poverty rates must be at least 20%, with an average family income less than 80% of the area average. As of now, there are about 8,7000 Opportunity Zones that have been approved by the U.S. Department of the Treasury, within the U.S. and its territories.

This government sponsored program is an economic development tool designed to boost development and job creation in distressed areas of the country.

Why Opportunity Zones Are Good Way To Get Out of the Stock Market

The good news for investors is that they can take money out of the stock market and invest in Opportunity Zones without getting taxed (for at least 10 years). To see the basic rules and detailed tax benefits of investing in Ozones, check out our article and podcast: Opportunity Zone Floodgates Ready to Open.

The Takeaway

Finally, there is no right answer when it comes to where to invest your money. Both the stock market and real estate market come with risks. When, where, and how you buy stocks, homes or rental properties, as well as holding onto your investments long-term, will lower your risk and increase the likelihood of a profitable return on investment.

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