Stocks versus real estate. Which one should you invest in?
Ideally, you will want to have both stocks and real estate in your portfolio because this will help you avoid over-exposure which possible when you don’t diversify. Moreover, each option has its specific merits, and there is no reason you can’t benefit from both options.
However, even if you invest in both stocks and real estate, you still want one of them to be your primary vehicle, as suggested by Upkeep Media agency. You will make better progress if you define your focus instead of spreading your energies and resources in many directions. As an investor, you want to know as much as possible about your chosen investment.
Narrowing it down to a focus lets you drill down and learn all there is to know about a specific asset class.
Why stocks and real estate?
First of all, why should the conversation be limited to just stocks and real estate? Why not think about other asset classes like certificates of deposit, government-issued bonds, crypto-currency, or Forex trading? The simple reason is that stocks and real estate are the most time-tested and least speculative asset classes with a high growth rate.
If you are looking for a long-term investment with capital growth and income potential, stocks and real estate are the best options. Real estate and stocks are regularly featured in the portfolio of high-net-worth individuals. They are a standard investment for mutual funds. There is a good reason why seasoned investors consistently choose stocks and real estate; these avenues can be trusted.
Stocks or real estate: Which should you choose?
When making this comparison, the first thing to understand is there is no easy way to do it. Trying to weigh the performance of stocks against the performance of real estate is like comparing oranges to apples. Also, unlike the stock market, it is hard to get reliable performance data for privately-owned real estate. When the data is available, it varies widely.
Here are the facts:
Over long periods, the S&P 500 index fund produces 9-10% returns. Meanwhile, in nearly eighty years, home values have only increased at an annual rate of 5.5%. When adjusted for inflation, the return on real estate drops to 1.5%. This is less than four times the rate of return for the stock market, which stands at 7% after it is adjusted for inflation.
At first glance, it does appear as if the stock market wins the contest hands down. But this might be because we are using criteria suited for measuring the performance of stocks rather than real estate. Certain aspects of real estate investing are not captured by these figures but are vital for reaching a correct verdict.
The effect of leverage on real estate returns
Theoretically, you can buy stocks with borrowed money. But this is not always a good choice because purchasing stocks with borrowed cash introduces massive amounts of risk into the investment. But when buying real estate, using borrowed money is not just a good idea but is recommended. You can buy a house using huge amounts of financing without increasing the riskiness of that investment.
Using borrowed money to buy real estate as leverage greatly amplifies the small returns from that property. Here is an illustration of how that works.
Picture two investors: investor X and investor Y. Both have $100,000 each. Investor X puts all his money into stocks to earn a return of 3%, which gives him $103,000. If investor Y puts all of his money into real estate and makes 3%, he would get the same results as investor X. But that is only if he does not buy the property using a mortgage.
But if investor Y took his money and made a 20% down payment on a $500,000 rental property, the returns would be completely different. Now instead of earning 3% return on his $100,000, investor Y will earn that 3% return on a $500,000 property. This will give him an additional $15,000 to his original investment. He would now have $115,000.
Other ways real estate is better than stocks
The explanation above does not take the potential cash flow from the property into account. Real estate investments will generate steady monthly income. This is not possible with stocks, even if that stock is dividend-paying. This is because stocks don’t typically pay dividends monthly, and investors often don’t know the amount of dividends a stock will pay.
The conclusion is if you consider stock versus real estate in terms of returns alone, stocks win. But the potential for higher returns from stocks is also offset by its relative volatility compared to real estate. Because real estate is a much more stable investment and you can amplify earnings by using leverage, real estate is a better investment option than stocks.
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