Both stock investing and real estate investing have the same basic financial objectives. People invest money in both to make money from growth and/or income. Growth through price appreciation (increase in value or market price) is where you really make money, the big bucks. Here we compare the two investment options in terms of profitability and other factors.
Let's talk about a $20,000 out-of-pocket 10-year investment in both investment options investing by traditional standards ... like it has normally been done throughout the past 50 or so years. No unusual economic circumstances, no HEAVY leverage (borrowed money) involved. Now let's look at both investment options.
Stock investing: The stock investment is $20,000 invested in a no-load S&P 500 Index fund which tracks the performance of the stock market. Over the long term the stock market has returned 10% a year. This is our assumed return, plain and simple.
Real estate investing: Here you buy a house in Middle America USA for $100,000, putting down $20,000, the traditional 20%. You average 3% a year in price appreciation. You rent it out to maintain an even cash flow. In other words, your rental income covers your mortgage payments, all repairs and maintenance, fees, taxes and so on. Plus, to keep it simple we assume that what you have paid off on your mortgage is absorbed by other expenses over the 10 years. So, if you were to sell after 10 years we will say that you still owe the bank $80,000. Sorry, this investment option is not so plain and simple to describe.
Let's compare the profitability of these investment options.
Stock investing produced yearly average returns of 10%. Over 10 years $20,000 grows to $51,875 when compounded at 10%.
Real estate investing produced average yearly gains of 3% on $100,000. Growing at 3% a year the value of your house grows to $134,392 in 10 years. We are assuming that you still owe the bank $80,000, so the net value of your investment is $54,392. In reality you would owe less with a conventional mortgage. On the other hand this difference could easily be offset if extraordinary costs were incurred over the 10-year period.
You had $20,000 of your own money invested to make money. The score after 10 years: Stock investing grew your money to $51,875 and real estate got you to $54,392 under our traditional assumptions. In terms of profitability there wasn't much difference.
But you and I both know that when you invest money to make money your success really depends on how well you know and play the game ... no matter what arena you invest money in. For example, if you are good at selecting, improving, managing and financing real estate properties you can do much better than the above example.
You can also make over 10% a year in stock investing if you know how to invest in the stock market. The problem for most folks is that they don't know how to invest in stocks, they are uninformed. Hence, stock investing for most folks is risky business.
On the other hand, TRADITIONALLY (not so in 2007-2009) many people are comfortable with real estate investing because they are familiar with real estate (they see it every day and likely grew up in a house). Real estate properties have historically gone up in value without many violent downswings. The stock market usually experiences a downturn (bear market) every few years.
Other basic differences in our two investment options follow.
Real estate properties require active management, and lack good liquidity as an investment. Selling a property can be costly and time consuming. On the other hand, real estate investing has traditionally been a good way to invest money and make it grow without taking much risk. Various investing techniques can be employed to enhance profits ... financial leverage being among them.
Stocks offer high liquidity, meaning that you can sell a stock investment quickly and easily with low costs. No active management is involved; you just buy or sell over the phone or on your computer. On the other hand, you are inviting trouble if you try to make money here and haven't spent time learning how to invest in stocks. Risk is always a factor when investing in stocks, especially if you are uninformed.
A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.
Jim is the author of a complete investor guide, Invest Informed, designed for average investors or would-be investors of all levels of financial background and experience. To learn more about investments and investing and his new financial guide go to http://www.investinformed.com
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