To grow your wealth, which is the better strategy: Investing in real estate or building a portfolio of stocks?
Many Americans do a bit of both: 65% of U.S. households are owner-occupied, according to the U.S. Census Bureau, and the Bureau of Labor Statistics says 55% of American workers participate in an employer retirement plan. If you’re among them, you likely have some exposure to the stock market.
It’s wise to know the advantages and disadvantages of each strategy.
It’s also important to know that you can purchase shares in real estate investments without the headaches of actually buying, managing, and selling properties.
Investing in real estate
Traditional real estate investments can be broken down into two broad categories: residential properties — like your home, rental properties, or flipping homes to buy, then resell for a profit — and commercial properties, such as apartment complexes, office buildings, and strip malls.
The pros
Investing in real estate is easy to understand:
While the home-buying journey can be complicated, the basics are simple: Purchase a property, manage upkeep (and tenants, if you own additional properties beyond your residence), and attempt to resell for a higher value. Also, owning a tangible asset can make you feel more in control of your investment than buying slivers of ownership in companies through shares of stocks.
2. Investing with debt is safer with real estate.
Also known as your “mortgage,” you can 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, is extremely risky and strictly for experienced traders.
3. Real estate investments can serve as a hedge against inflation:
Real estate ownership is generally considered a hedge against inflation, as home values and rents typically increase with inflation.
4. There can be tax advantages to property ownership:
Homeowners may qualify for a tax deduction for mortgage interest paid on up to the first $1 million in mortgage debt. There also are 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 if you’re single (or $500,000 if you’re married and filing jointly). If you own and sell commercial property, you may be able to avoid capital gains through a 1031 exchange (if you reinvest proceeds in a similar type of property). And investment properties can earn tax breaks through depreciation or writing off wear and tear on the property.
The cons
Real estate investments can be more work than stocks:
While purchasing property is easy to understand, that doesn’t mean the work of maintaining properties, especially rental properties, is easy. Owning properties requires much more sweat equity than purchasing stock or stock investments like mutual funds.
2. Real estate is expensive and highly illiquid:
Investing in real estate, even when borrowing cash, requires a large upfront investment. Getting your money out of a real estate investment through resale is much more difficult than the point-and-click ease of buying and selling stocks.
3. Real estate has high transaction costs:
A seller can expect to pay significant closing costs, which can take as much as 6% to 10% off the top of the sale price. That’s a hefty cut compared with stocks, especially now that most brokers charge no fees for stock trades.
4. It’s difficult to diversify your investments with real estate:
Location matters when investing in real estate. Sales may slump in one area, while values explode in another. Diversifying the purchase of real estate properties by location and type (a mix of residential and commercial, for example) requires much deeper pockets than the average investor has.
4. The return of your investment isn’t a sure thing:
While property prices tend to rise over time, there’s always a risk of selling a property at a loss — the 2008 financial crisis is a reminder of that. This is also true of stocks, of course.
Investing in stocks
Buying shares of stock has significant pros — and some important cons — to remember before you take the plunge.
The pros
Stocks are highly liquid:
While investment cash can be locked up for years in real estate, the purchase or sale of public company shares can be done the moment you decide it’s time to act. Unlike real estate, it’s also easier to know the value of your investment at any time.
2. It’s easier to diversify your investment in stocks:
Few people have the time — let alone the cash — to purchase enough real estate properties to cover a broad enough range of locations or industries to have true diversification. With stocks, it’s possible to build a broad portfolio of companies and industries at a fraction of the time and cost of owning a diverse collection of properties. Perhaps the easiest way: Purchase shares in mutual funds, index funds or exchange-traded funds. These funds buy shares in a wide swath of companies, which can give fund investors instant diversification.
3. There are fewer (if any) transaction fees with stocks:
While you’ll need to open a brokerage account to buy and sell stocks, the price war among discount brokers has reduced stock trading costs to $0 in most cases. Many brokers also offer a selection of no-transaction-fee mutual funds, index funds and ETFs.
4. You can grow your investment in tax-advantaged retirement accounts:
Purchasing shares through an employer-sponsored retirement account like a 401(k) or through an individual retirement account can allow your investment to grow tax-deferred or even tax-free.
The cons
Stock prices are much more volatile than real estate:
The prices of stocks can move up and down much faster than real estate prices. That volatility can be stomach-churning unless you take a long view on the stocks and funds you purchase for your portfolio, meaning you plan to buy and hold despite volatility.
2. Selling stocks may result in a capital gains tax:
When you sell your stocks, you may have to pay a capital gains tax. If you’ve held the stock for more than a year, however, you may qualify for taxes at a lower rate. Also, you may have to pay taxes on any stock dividends your portfolio paid out during the year. (Understand more about taxes on stocks.)
3. Stocks can trigger emotional decision-making:
While you can buy and sell stocks more easily than real estate properties, that doesn’t mean you should. When markets waver, investors often sell when a buy-and-hold strategy typically produces greater returns. Investors should take a long view of all investments, including building a stock portfolio.
