To grow your wealth, which is the better strategy: Investing in real estate or the stock market? Many Americans do both: 65% of US households are owner-occupied and 55% of American workers participate in an employer retirement plan (likely including exposure to the stock market). But if you’re new to investing or looking to double-down on either type of investment and choosing between the two — it’s wise to consider the ins and outs of each strategy.
Traditional real estate investments can be broken down into two main categories: residential and commercial properties. Residential properties include your home, rentals and house flipping and commercial properties include apartment complexes, office buildings and malls. Real estate investors make money through rental income, appreciation, and profits generated by business activities that depend on the property. What are some factors to consider when investing in real estate – and stocks for that matter?
“90% of all millionaires become so through owning real estate.” This famous quote from Andrew Carnegie, one of the wealthiest entrepreneurs of all time, is just as relevant today as it was more than a century ago. The most successful people in the world have historically built their wealth through real estate. The benefits of investing in real estate are numerous. Investors can enjoy predictable cash flow, passive income, excellent returns, tax advantages and diversification and leverage, just to name a few.
When it comes to building real wealth, the stock market can be a bit of a coin toss. Unless you work on Wall Street, the average investor typically leans toward low-risk investments. It’s always wise to invest your money in some way, but in order to see real growth in the stock market, you must take a big risk.
One pro of investing in real estate is that it’s easy to understand. While the home buying journey can be complicated, the basics are simple: purchase a property, manage upkeep (and tenants, if you’re acting as a landlord), and attempt to resell for a higher value. Owning a tangible asset can also make you feel more in control of your investment than buying small fractions of ownership in companies through shares of stocks.
Owning stocks is a bit more complicated, as stocks are intangible and their prices tend to move up and down much faster than real estate prices. That volatility can cause anxiety unless you’re well versed in your investments and plan to buy and hold long term, despite volatility. Stocks are also known to trigger emotional decision-making. Just because you can buy and sell stocks more easily than real estate properties, doesn’t mean you should. When markets waver, investors often sell when a buy-and-hold strategy typically produces greater returns. We encourage investors to take a long view of all investments and build a stock portfolio.
Debt and Inflation
How about investing with debt? If you have any amount of debt, it’s safer to invest in real estate than in stocks. Your mortgage allows you to invest in a new property with a 20% down payment or less and finance the rest of the property’s cost. Investing in stocks with debt (known as margin trading) on the other hand, is extremely risky and only advised for experienced traders. Real estate investments also tend to hold their own against inflation. Home values and rents typically increase over time and even with inflation. With a good investment, you should be able to turn a profit when it’s time to sell.
Not in a place to flip homes or build a rental property empire? Thankfully, there is an alternative to traditional real estate. REITs, or real estate investment trusts offer a way to invest in real estate without having to own, operate, or finance properties. REITs are companies that own and operate income-producing real estate, such as apartments, warehouses, offices, malls and hotels. The most reliable REITs have a strong track record for paying large and growing dividends. Many brokers offer publicly traded REITs and REIT mutual funds and ETFs.
There can also be tax advantages to real estate investment. Property owners can take advantage of various tax breaks and deductions to save money. In general, you can deduct the reasonable costs of owning, operating, and managing a property. Homeowners may qualify for a tax deduction for mortgage interest paid on up to the first $1 million in mortgage debt. There are also tax breaks when you sell a principal residence, such as an exclusion that may allow you to avoid capital gains taxes on net proceeds of $250,000-$500,000. Investment properties can earn tax breaks through depreciation, or writing off wear and tear on the property.
When it comes to investing in stocks, you may be faced with tax disadvantages. Generally, any profit you make on the sale of a stock is taxable at either 0%, 15% or 20% in a capital gains tax if you held the shares for more than a year, or at your ordinary tax rate if you held the shares for a year or less. Also, you will likely have to pay taxes on any stock dividends your portfolio paid out during the year.
There are things you need to have prepared when you’re ready to invest in real estate. You’ll need a large upfront investment and the funds to cover closing costs. You’ll also need to do significant research on the region. If you have any investment questions or any thoughts on this post, please drop us a line in the comments!