In this article, I am going to compare two prevalent types of investments—stocks and real estate—so you can determine which, if either, is the best option for you.
The case for investing in stocks
Investing in stocks is the most common way for people to start investing. It’s quick and convenient, and the learning curve is relatively small.
I recommend you read our full guide on how to start investing, but for now here are a few of the routes you can take with stock investing:
I’d recommend investing in individual stocks once you have a firm understanding of the markets and how stocks work.
You significantly reduce your diversification and increase your risk by investing in just a handful of individual stocks. The reward can be higher, though, because you become more targeted.
To do so, though, you need a strategy and firm grasp on investing. If you want to begin investing in individual stocks, I always recommend a value investing strategy.
Index funds and Exchange Traded Funds (ETFs)
ETFs are basically a basket of stocks that act as a single stock. You purchase it like you would an individual stock, but it’s basically a fund that encompasses multiple other stocks.
For example, you can buy an ETF that has Google, Amazon, and Facebook all in one—so you get exposure to all three companies.
Index funds are similar but are structured differently and often require a minimum investment amount.
Mutual funds are often managed by a person or group of people. These fund managers make the decisions about what stocks the fund holds and how much of each they want to invest in.
There are pros and cons to this as you can imagine, but some people feel more comfortable having a human managing their money versus an algorithm (created by robo-advisors).
Who to invest with for stocks
Our favorites for traditional fund managers are:
Fidelity is one of the largest financial services companies in the world. As of the end of 2017, the company had $2.45 trillion in assets under management.
Fidelity offers stock options and ETFs. Fidelity even offers a robo-advisor—Fidelity Go— if that’s what you’re looking for.
Read our full Fidelity review
Like Fidelity, Vanguard is one of the largest financial companies around. They pioneered index funds, but they also offer ETFs.
Here are 17 of the top Vanguard funds
Pros to investing in stocks
Obviously, there are benefits to investing in the stock market. Otherwise, nobody would be doing it. Here are some of the most considerable advantages of investing in stocks:
1. Easy to buy and sell
One of the most significant benefits of investing in stocks is how easy they are to buy and sell.
Just sign up for a brokerage account, deposit money, and you can purchase shares immediately. The same goes for selling. If you decide you want to unload some stocks from your portfolio, just place an order to do it.
2. Historically large gains
Over the last nearly 100 years, the average investment gain on stocks has hovered around 10 percent. Over time, that’s a pretty good return on investments. In fact, here’s what CNN Money says:
“Stocks historically have produced long-term gains that are bigger than those of any other asset class. Since 1926, large stocks have returned an average of 10% per year. What’s more, they didn’t lose ground during any period of 20 years or longer during that time. Those qualities make stocks much more appealing for long-term savings than, say, Treasury bonds (which have had about 5.6% average annual gains since 1926) or stashing cash under your mattress.”
Now, we all know that past performance does not indicate future returns, but with a well-diversified portfolio, you are often doing the best you can to position yourself for success. You’re also staying ahead of inflation, which averages just over three percent per year.
If you take a value investing approach, you know that investing in stocks that pay a dividend is vital.
When companies earn money, they typically choose to either reinvest that money into the business and pay no dividend (common with tech companies) or pay a portion of those earnings back to their shareholders. If you have stock in a company that pays a dividend, it’s like getting rental income, only on a much smaller basis.
With stocks, it’s easy to diversify your investment portfolio. This is especially true if you invest in things like index funds or ETFs—which give you instant diversification by investing in a multitude of companies and/or industries.
Having a diverse spread of assets in your portfolio is one of, if not the, smartest things you can do as an investor. This is a primary reason companies offer 401(k) accounts with diversified funds instead of giving you part ownership of the building the company owns (see below on real estate’s illiquidity).
5. Technically, you own part of the company
Buying shares of stock is buying part ownership of a company. Now, a single share of stock in a large company like Google means almost nothing. Most major institutional investors only own a fraction of a percent of the company.
Still, though, knowing that you own part of the company is kind of cool. And if you own enough, or if you own specific types of shares, you may be entitled to voting rights when the company votes on changes.
Cons of investing in stocks
Investing in stocks comes with risks, too. Here are some of them you should be aware of:
1. Short-term volatility
Unless you’re a skilled (and lucky) day-trader, stocks have a lot of short-term volatility. Meaning, they can increase or decrease in value very fast after you buy them.
This is normal and is a reflection of how the stock market works, but investing in stocks is not a get-rich-quick scheme. Most successful investors take a buy-and-hold strategy and plan to hold onto their investments for an extended period of time. I’d advise you do the same due to this risk.
2. You can lose your entire investment
See Enron. Okay, maybe that’s not a fair comparison, but the truth is when you invest in stocks you can lose it all.
You’re investing in the company, and if that company goes under, so does your investment. In some cases, you’ll get something back after the company goes down, but most times you won’t.
Since the Enron incident, investors are a lot more cautious in how they evaluate companies, and there are new rules and regulations on how companies report their earnings.
So you have tools and resources available to you, but if you have no idea what you’re doing it won’t help. Make sure you’re comfortable with how stocks work and do a lot of financial research on the companies you choose to invest in before making any decisions.
3. Individual stocks are a pain to analyze
First of all, for most investors, I recommend buying index funds. It’s easier, it gives you diversity, and you mitigate your risk. But if you want to invest in individual stocks, more power to you.
The danger, though, is that good stock analysis requires a lot of time and knowledge. I have two degrees in finance, and I’m still touching the tip of the iceberg when it comes to in-depth analysis.
Because of the risk, don’t just trust a magazine or blog on stocks to pick, talk to a financial advisor or make sure you know exactly what you’re doing before investing.
4. It can be very stressful
Due to the ups and downs of the market, investing in stocks can be very stressful. The market reacts to some news and not others—you never really know what stocks are going to do.
Good investors can take an educated guess, but it’s impossible to predict the performance of a stock. Know this going in, and know that over time, history has shown stocks to perform well.
The goal is not to obsess over how your stocks are acting on a daily basis. Check in every quarter or a couple times a year to see how you’re doing and where you need to rebalance.
5. Not a good option for retirement income
When you’re younger, and your investment horizon is 30+ years, you can put darn near all of your money into stocks. As you get older and closer to retirement, though, this number will change.
When you hit retirement, you’ll want to have most of your money in less volatile assets, such as bonds or money market accounts. For this reason, stocks are not a good option for retirement income. In retirement, you’ll need a consistent source of regular income to pay for living and medical expenses.
The case for investing in real estate
For a lot of investors, putting their money into real estate feels a lot better. With stocks, you can’t see or feel them. You just look at charts. But with real estate, you can physically walk into a property that you’ve purchased and see what your money has bought you (sometimes that’s good, sometimes it’s bad!).
I think for a long time, people associated real estate investing with consistent and large returns on investment. That’s not always the case anymore, and much of it depends on your geographic market. It also depends on how well you know that market.
When investing in real estate, there are two primary options you can take:
Becoming a landlord
Investing in residential properties is exactly what it sounds like. You buy a house as an investment, usually to rent out and capitalize on the rental income. Investing in residential properties has been the most common path for a long time—primarily because investors are drawn to the (almost) guaranteed monthly income it produces.
It’s also easier to manage a home than a commercial building.
The other side to residential investing you see is “flipping.” Flipping property is when you buy it at a reasonable price, upgrade it, and sell it within a short window of time.
Flippers don’t have the intent of having rental tenants or holding onto the property for long. Flipping in some regions of the country can produce huge gains, but you are also taking a significant risk, hoping that your home improvements will pay off.
Investing in commercial real estate can come in a variety of flavors. You can buy an office building, an apartment building, or even a commercial storefront that houses a variety of retail shops.
Commercial real estate investing is complex, requires a lot of up-front capital, and you’ll need to have a reliable system in place to be able to manage it all (maintenance workers, accounting, property managers, etc.).
Who to invest with for real estate
EquityMultiple is a real estate crowdfunding platform that allows individual investors to invest in different commercial properties for just $10,000.
They have closed more than than $75 billion in real estate deals since their founding in 2002.
Roofstock is the #1 online marketplace for finding real estate investments. Their platform is easy-to-use, with many of their rental properties right on the homepage as soon as you sign in.
Signing up for Roofstock is free, and their fee is just a 2.5% marketing fee. Compared to the 6% folks usually pay, this is a great deal.
Pros of real estate investing
Like all investments, investing in real estate can have a lot of upsides. Most of the financial benefits come in the form of tax deductions (please note, I am not a tax professional, and you should seek the advice of one when you’re looking to take advantage of these tax deductions).
That said, here are some of the benefits of investing in real estate:
1. The insane tax benefits
Depreciation is a tax and accounting tactic where you spread out the cost of a physical asset over what is considered its “useful life” to account for the loss in value that asset will incur over time.
When you do your taxes, you can deduct the cost of the property, via depreciation, as a business expense. In most cases, this will apply to commercial properties as wear and tear.
Now, this is a complicated tax methodology, and I would advise that you have a tax professional help you with this, so you ensure you’re following tax rules and regulations.
Mortgage interest rate deductions
This is typically your most prominent real estate deduction at tax time, and it reflects the interest you took for the loan on your property.
At tax time, you can deduct the interest you paid on any first or second mortgages up to $1 million in debts for married people filing jointly. Interest paid on mortgages higher than $1 million is ineligible to be deducted.
As you can imagine, the savings can be significant here, mainly when you’re investing in commercial properties.
Costs of repairs and general upkeep deductions
Generally speaking, the cost of any repairs you do to the home is tax-deductible as it’s written off as a business expense.
These have to be repairs that are needed to maintain your rental property. Things, like fixing a damaged pipe or repairing the electrical, would apply.
Where you have to be careful is with repairs that may be considered “improvements.” Things, like redoing a kitchen or adding new appliances, may qualify as improvements, in which case you can’t deduct the entire expense.
Travel costs and cost of services deductions
If you hire a property management company or require any type of legal counsel, you can deduct these expenses from your income at tax time. If you incur any costs traveling to the property to do inspections or repairs, for example, you can deduct those too (mileage, materials, etc.).
Property tax deductions
You can deduct the cost of your property taxes on real estate.
Deferral of capital gains via 1031 exchange
This one is a little trickier but can pay off big. Section 1031 is an Internal Revenue Code provision that allows you to defer any capital gains taxes you’d pay when selling a property when followed correctly.
Also known as the Starker Loophole, if you sell the property through this 1031 exchange, you’ll pay no capital gains taxes when you invest that money into a similar property.
2. Real estate is tangible and real
As I mentioned before, one of the most significant advantages to investing in real estate is you can physically see what you’ve purchased as your investment.
You can walk into the house and see with your own eyes what needs to be repaired, for instance. With a stock, you can’t just walk into a company’s manufacturing plant and make changes at will.
3. Recurring income
Investing in real estate allows you to earn a recurring cash flow every month. By purchasing property and renting it out, you keep whatever is left after all the bills are paid.
Some people own nothing but revenue-earning properties and have a property manager so they can set it and forget it.
4. Value up, loan balance down
Over time, you’ll pay your loan balance down. If you chose a 15-year mortgage on a residential property, for example, you’ll owe nothing after 15 years, and you’ll have an incredibly valuable asset on your hands. A
t that point, all you’ll owe is property taxes and your profit margins when renting will be much higher. At the same point time, historical data shows us that home values will tend to increase over time. So over these same 15 years of paying your balance down, the value of the property itself will have hopefully gone up so you can sell it at an even more substantial gain if you’d like.
5. Complete control
When you own real estate, you’re in full control. If you want to sell the property, you can. If you’re going to increase rent, you can.
If you’re going to evict the tenant because they haven’t paid and you want to renovate the property entirely, you can.
Unlike other assets, what you own is ultimately yours to do with as you’d like. For the right businessperson, this is a liberating feeling.
Cons of real estate investing
Investing in real estate isn’t all sunshine and rainbows. There are plenty of downsides, including:
1. Lack of liquidity
When you own a piece of property, you can’t just decide one day you want to sell it at the close of the market day, like you can with a stock. You can’t back out at a moment’s notice when you’re feeling you don’t want to own the investment—whether the value is decreasing or some major news hits your life.
This is one of the biggest downfalls of investing in real estate. Say you lose your job and your only tenant defaults on their payment. You’re stuck. It’s scary, but with real estate, you need to have to diversify to balance your risk.
2. Up front costs
In most cases, the cost to get into a real estate investment is significant. You have closing costs, taxes, commissions, fees, and all other types of upfront costs you would when buying a home—only you’re doing it for an investment.
Yes, many of these things are deductible at tax time, but that doesn’t mean you don’t have to have the cash up front. You’re also taking a risk in filling the property with a tenant, if you choose to rent it, or selling it in a short enough time period if you’re flipping it. With the costs you will incur to own the property, this is a significant risk.
3. Unknown future values
While we can hope and, in some cases, assume that the value of our investment properties will increase over time, there is no guarantee.
Property values can fluctuate significantly over time, and it usually happens in long waves—meaning it will take time to increase and decrease.
Unlike a stock, which can tank 20 percent in one day, a property might take 15 years to do that. This means you can’t plan and prepare as quickly as you’d like. Forecasting becomes a challenge because of this. You’ll need to stay on top of the geographic market as well as broader real estate trends to mitigate your risk.
4. Lack of diversification
If you’re putting all of your money into real estate (and in some cases, you have to because of the cost) you’re limiting your diversification in how you invest.
With stocks, you can buy an index fund or mutual fund and have instant diversification. With real estate, you can’t. Even REITs are relatively limited because it’s still real estate. I would recommend having a diversified investment portfolio before sinking all of your money into real estate. As they say, don’t put all your eggs in one basket.
5. Bad tenants and legal issues
This can be a significant risk to real estate investing. While you can do your due diligence to find a suitable tenant, it’s not always guaranteed.
A good friend of mine had a beautiful property that he rented to someone with excellent credit and stable employment history. He even knew the guy personally. After a few months, the guy decided not to pay, and my friend had to go through all kinds of legal battles to evict him from the property.
This is a real scenario, and it can happen to you. So make sure you have a lawyer you can trust, and you do as much research as possible when selecting tenants.
Only you can determine which method is best for you. Now, though, you know what it takes to get into each of these investment types as well as the pros and cons of each. Both of these options come with risks and rewards, and both are suitable for most people. The question is – which investment option will you choose between the two?
- EquityMultiple: Secure Real Estate Investing At A Low Cost
- Why The Stock Market Really Is The Best Place To Grow Your Money