Joseph Hogue, Wealth of Geeks
The closer you are to retirement, the less risk you can afford to take with the money you’re investing. If investing is an age-old strategy to ensure that you can relax, travel, and enjoy your hard-earned retirement years at some point in life, where do you draw the line?
There are several tactics to growing your wealth through investing. The best approach is to invest early and continue to do a little each month. Your initial investment will grow over the long term, and the idea is that you’ll eventually be able to live on just the interest that a large principal amount generates.
The most common is investing in the stock market through an employer-sponsored 401(k). You can also invest in stocks on your own, which means you can access those funds at any time — as opposed to a retirement account where you must reach a certain age to withdraw funds penalty-free.
Investing in real estate is another way many investors grow their wealth. And since there are no restrictions on how you use any profit you generate, this tactic may even allow you to retire early.
Let’s dive into the pros and cons of both real estate investing and stocks.
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Real estate pros
• Relatively safe strategy
When you “buy and hold” rental property, you’re investing in a relatively safe strategy. Real estate doesn’t tend to have large fluctuations in value. Instead, it has historically increased slowly over time. Plus, in any economy — whether it be an economic boom, recession, or depression — people need a place to live. So while market rents may vary, there will always be a need for affordable rental housing.
• Immediate cash flow and passive income
Real estate investing can be as hands-on or as hands-off as you make it. You may generate more monthly cash flow by managing your properties and doing repairs independently. However, if you still have a busy day job or simply don’t want to deal with it, you can also pay a property management company to handle all that for you while maintaining property ownership.
Having positive cash flow means your tenants essentially pay all the bills, including your monthly mortgage payment. This means you’re building equity without having to contribute any of your own money on a monthly basis.
• Leverage
Real estate allows you to generate interest on borrowed money in the form of a mortgage. While you don’t need to have the full amount of the home’s value invested on your own, you get to realize the full return — be that monthly rent or property appreciation.
• Tax deductions
If you’ve ever heard that investing in real estate is great for your tax deductions, it’s true. The IRS allows you to deduct expenses like owner-paid utilities for your properties, mileage, and portions of bills related to your business, like your cell phone or internet service.
On top of that, you can depreciate your property. When depreciating, you can allocate the cost of your property over its useful life, thus reducing its taxable income. Perhaps one of the biggest tax benefits to real estate investing is that — unlike other entrepreneurial businesses — profit from a rental property is taxed as ordinary income and not subject to self-employment tax, which would be a whopping 15%, in addition to your normal income tax rate.
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Real estate cons
• Time and energy
While you may be able to outsource the management of your real estate property, you’ll still spend some time and energy purchasing the property, fixing any needed maintenance issues, and setting up the workflow. Plus, you’ll have to put in some time during tax season.
• Real estate isn’t liquid
It can be difficult to access when you tie your money up in properties. If you need to sell in a pinch, you could sell for less and still have to wait 30-60 days before you have access to the money.
• Bad market conditions
Real estate generally increases in value over the long term, but it does have its downswings. If you’re not looking at investing long-term and you don’t have much equity built up, it could catch you off guard. This happened during the real estate market crash of 2008. Many investors were “under water,” meaning the value of the properties they owned dropped below what they still owed on the mortgage.
They were either forced to keep the property — even if it wasn’t generating a profit — or sell quickly and have to pay with money out of their pocket to pay back the bank for the mortgage.
• The costs of selling real estate
While you can move money in and out of the stock market with ease and little expense, real estate can be a bit more difficult, especially if you’re selling. Closing costs for sellers average 5% to 6% of the final selling price. On a $100,000 investment property, that’s $5,000 to $6,000.
If you are selling, consider working with a discount agent to save on commissions. Also, keep in mind how you may be able to avoid paying capital gains on your sold investment property by using the 1031 exchange.
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Stock pros
• Gains over time
Historically, stocks have increased in value over time. The S&P 500 averages 9% to 10% ROI annually. While this isn’t true every year, stocks should increase in value over the long haul.
• Own part of a business with no work required
When you own stocks, you essentially own a portion of a company but don’t have to do any work for them to turn a profit. You simply allow them the use of your invested money and realize a return on that money if the company does well. Stocks are the most passive investment vessel you can find.
• Easier diversification
You can own as many different stocks as you desire and even a portion of a share. This allows for easy diversification among both industries and companies. You can even diversify how risky your portfolio is. When investing in real estate, you must own the entire property — unless you’re investing via real estate investment trusts (REITs)- and would need much more money to diversify in the same way as the stock market.
• Liquidity
Stocks are very liquid when compared to real estate. In fact, most trading platforms allow you to move money to your banking account with the click of a button. This can be helpful if you think you may need to access the funds at a later date but want to put them to use in the near future.
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Stock cons
• Economic downturns can cause major loss
While stocks generally increase in value over the long term, there may be periods of an economic downturn in which your stocks lose a huge amount of value within a couple of hours. And while it may be your first instinct to panic and pull out the rest of your money, it’s best to remain unemotional and detached from your investment during this time. The market will usually correct itself, and your investments will increase again.
• Stock prices fluctuate frequently
Unlike real estate, stock values change by the minute. While you may be able to get ahead of a slowly falling real estate market, stocks can be a bit more tricky. Plus, they may go up again quickly, so it’s not always a good idea to pull out your money in a panic.
• High risk
While you may be able to increase your wealth by investing in the long term, trying to make a large profit through stocks can be difficult. You can buy into riskier stocks in the hopes that they pan out. But remember that you have no say in the company, so you can’t affect its trajectory. This in and of itself makes stocks risky — profit and loss are out of your hands.
• Time-consuming
If you want to play the short-term game, you’ll need to pay close attention to the market to know when to buy in and when to pull out funds. But, if you’re playing the long term, you’ll need to be okay with sitting on the sidelines and letting the market go without any capacity to change it.
In both types of investments, it’s imperative that you do your research, so no matter what, don’t go in blind.
