• Sat. Oct 16th, 2021

Should you invest in stocks or real estate?

Bynikholas

Jan 23, 2021 , , ,

To invest in real estate or stocks — or both? That is the question.

Deciding whether to invest in stocks or real estate requires being honest about your risk tolerance and lifestyle preferences. Both investment strategies have their advantages and disadvantages, so it really comes down to your financial goals and budget.

Understanding the differences between the two will help you determine how to move forward. Let’s take a look at the benefits and drawbacks of both and then discuss which investment makes the most sense for your portfolio. Spoiler: it might make sense to invest in both.

Real estate vs. stocks

Investing in real estate means you acquire a physical piece of property. Regardless of the type of real-estate investment you make, most investors make returns on monthly rental income and/or when they sell the property for an appreciated value.

On the other hand, when you buy shares of stock, you purchase a piece of a company. As the company’s value grows, your stock value also grows. You can also receive income in the form of dividends on your shares if you hold on to your stocks over time.

An alternative to purchasing physical property is investing in real-estate investment trusts, or REITs. REITs are individual companies that own income-producing assets in the commercial real estate space such as office complexes, retail spaces, hotels and apartment buildings.

Many REITs are publicly traded like stocks and tend to pay higher dividends than their equity counterparts. REITs, like stocks, allow you to reinvest these dividends and build your investment value. For this reason, they are quite a popular option for retirement investment accounts.

Stocks

To buy stocks, you will have to go through a broker, or an entity authorized to buy stocks. You can use a brokerage firm, individual broker, and even online platforms or robo advisers. Increasingly, many investors choose to use online investing platforms for their convenience and low costs.

Before the advent of free stock trading apps, working with a brokerage firm required making a minimum deposit and maintaining an account value alongside paying brokerage fees for making trades.

In recent years, apps like Robinhood allow investors to start trading with as little as one stock and zero fees. Many even offer free sign-up bonuses.

Stock investing advantages

Stocks are liquid. With real estate, your money could be tied up for many years until you decide to sell. In the stock market, however, you can buy and sell public company shares at a moment’s notice.

Proven track record of success. Despite the many stock market crashes, buying stocks, reinvesting the dividends and holding for long periods of time has proven to be the greatest wealth generator in history. However, you need to keep your emotions at bay when ups and downs inevitably happen to see actual returns.

Earn dividends. Investing in high-yielding dividend stocks can generate significant passive income which you can then reinvest. If you hold on to these stocks long-term and continue to reinvest the dividends, you will see your net worth snowball after a few decades into true generational wealth.

Easy to diversify your portfolio. According to Warren Buffett, “The goal of the nonprofessional should not be to pick winners — neither he nor his ‘helpers’ can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well.” Basically, with stocks, it is much easier to build a diverse portfolio of investments with investments like index funds across a range of sectors. Whereas with real estate, it is much more difficult to achieve true diversification.

Downsides of stocks

An emotional roller coaster. Investing in the stock market requires a cool head and discipline. Many investors run the risk of losing money because they let their emotions get in the way of their investments and cash out at the wrong time. For instance, during the Great Recession, many financial advisers told clients to sell their assets after the market had crashed, when they really should have been buying at that time.

Short-term volatility. If you’re looking to make money fast, then stock price volatility could work for or against you. Stock prices can vary drastically from day to day. If you don’t understand what’s going on in the market or with the companies you’ve invested in, this could cause you severe stress. However, over the long-term, the highs and lows are usually smoothed out for well-valued stocks.

Capital-gains taxes. You may have to pay capital-gains taxes after you sell your stocks, and your dividends could also be taxed. On the other hand, there are long-term capital-gains rates for those who hold on to stocks for longer than a year.

Real estate

There are many ways to invest in real estate, from long-term and short-term rental properties to fixer uppers and house hacking. Understanding your budget, finding the right lender and knowing the amount of work you want to put into your investment ahead of time will help tremendously.

A real-estate agent in your state can help you find a property that suits your goals.

Real estate advantages

A hedge against market volatility. Owning property can serve as a hedge against stock market volatility and inflation, as home values and rent prices tend to appreciate with inflation.

Tax advantages. There are a plethora of tax advantages for homeowners and commercial real estate owners. For example, qualified homeowners can deduct the mortgage interest paid on the first $750,000 in mortgage debt. Commercial real estate owners can also avoid capital-gains taxes through a 1031 exchange if they reinvest in a similar type of property with the funds or use MACRS depreciation to lower their taxable income.

Cash flow. Real-estate investments can offer owners a reliable, passive monthly income through the form of rent payments.

Real estate downsides

Real estate requires time and money. If you’ve invested in a rental property or fixer-upper, then expect to put a lot of time and money into the project. Being a landlord is no easy task, and you’ll be on the hook for repairs and problems that arise with the home.

Your money is tied up. Investing in real estate is highly illiquid, meaning you will not be able to access your returns for quite some time. This is especially true if you pay cash for your rental property. Selling property is also more difficult than selling stocks.

Tons of fees. There are many transaction costs involved with buying and selling property. Sellers can expect to pay 6{911ea05452e114f1778c76ca86733b6032c246f8f651bb1f01d12abf04b54efb} to 10{911ea05452e114f1778c76ca86733b6032c246f8f651bb1f01d12abf04b54efb} of the home’s sale price in closing costs, including agents’ fees, while most brokers charge no fees to sell stocks.

Not easy to diversify. To have a truly diversified real-estate portfolio that is representative of multiple locations and building types, you will need large sums of money that most laypeople simply don’t have. Thankfully, REITs and crowdfunding apps have made this more achievable.

Diversifying your portfolio

As an investor, it is never a good idea to put all of your eggs in one basket. Therefore, when it comes to investing in stocks and real estate, most Americans do both.

According to the U.S. Census Bureau, 60{911ea05452e114f1778c76ca86733b6032c246f8f651bb1f01d12abf04b54efb} of U.S. households are owner-occupied, and the Bureau of Labor Statistics says 55{911ea05452e114f1778c76ca86733b6032c246f8f651bb1f01d12abf04b54efb} of American workers participate in an employer retirement plan, meaning they have some exposure to the stock market.

Ultimately, stocks and real estate both have their benefits. Make sure to do your research and determine what you’re willing to risk before moving forward. Going in with a plan, and having the willingness to be flexible with that plan, is the key to generating significant returns.

Riley Adams is a CPA and the author of the Young and the Invested website, which focuses on financial independence and investing.