When it comes to investing, achieving the highest return is the objective, while minimizing the risk of course.
While there are thousands of great investment opportunities out there, it’s impossible to invest in all of them. Although we can try to maximize our diversification by investing in indexes through ETFs as I discussed here, sometimes we are faced with a tough choice.
A good example of this and something that I’m sure most people and investors have considered is the subject of today’s article:
Should I invest in Stocks or Real Estate?
This is a great question, which I will try to clarify in this article. We shall look at both the advantages and disadvantages of each asset and try to determine when to invest in each and who should invest in each.
Let’s start with real estate.
Advantages of Real Estate.
When we talk about real estate, most people think about buying/selling a house or apartment. This is residential real estate. The other main category is commercial real estate, which refers to real estate which is used for commercial purposes; offices, shops, bars…
Real Estate is Real
One of the advantages, or at least one of the reasons so many people are attracted to real estate, is that it is a physical tangible asset.
Unlike stocks, you can actually touch your investment, which makes a lot of folks feel more comfortable with investing in a house, in some cases even a little too comfortable…
On the other hand stocks are just numbers on a screen, which do not inspire much confidence to those who don’t really understand much about it.
Leverage is a term used in finance quite often. All it really means is that you are making an investment with money you don’t have. You are essentially borrowing money to invest. We call it leverage because you are essentially leveraging a small amount of money. If you have 100 pounds and a “leverage” of 10:1 you can invest 1000.
Leverage is often used by traders in forex markets, for example.
Although one can buy a house with cash, this is rare. Most people who think about buying a property do so by getting a mortgage. A mortgage is a loan from the bank, which has the specific aim of financing the purchase of a house and uses said house as collateral. Because of the way our banking system works it is actually quite “easy” to get a mortgage. While I do not think mortgages are great in themselves it would be wrong to deny that there is an advantage to this.
By getting a mortgage you can buy a house today, at today’s prices, which should be cheaper than in the future, and pay back the mortgage during a comfortable 10, 20 or even 30 year period.
Thanks to mortgages, people can punch above their weight, for better and for worse.
Tax Benefits and Deductions
Buying a house can also have certain fiscal benefits.
With commercial properties, you can deduct depreciation and wear and tear from your taxes.
Another great benefit that can come from real estate investment is the ability to defer your capital gains tax. Normally when you sell a financial asset you have to pay tax on it.
However, legislation in certain countries such as U.S. and U.K: allow you to defer this payment if you re-invest the money in a similar property.
Some savvy investors use this method to continually trade up, taking advantage of price increases without paying any tax until the end of the line.
I am not a tax law expert so if you’d like to know more about this click .
Disadvantages of Real Estate
Everything has a downside, even real estate, despite what you might have been told before 2008.
Mortgages are expensive
Let’s not forget that acquiring a mortgage means committing to paying back a significant amount of debt, normally for quite an extended period of time.
First of all, acquiring debt is never a good idea. You should avoid it at all costs, this is personal finance 101. You are losing money every month to interest payments, instead of gaining it.
Instead of paying the bank back 1000 pounds, think about what you could do if you invested that money every month in the stock market. You would not be in debt, and you would be gaining interest, not losing it.
Furthermore, a mortgage entails a very long commitment. The future is uncertain, and you may find yourself in a situation where you cannot make your mortgage payments due to unexpected circumstances.
It’s an Illiquid Investment
What I mean by this, is that it’s hard to pull out of buying a house, especially with a mortgage. You’ve got to commit to not use those funds for a long time. In many cases, you may have to hold the property for several years to realize its true profit potential. Also, the closing cost can add up to thousands of dollars, and include taxes, commissions, and fees. Further, real estate prices have a tendency to fluctuate.
The Housing Market Doesn’t Always Go Up.
While in a long enough time frame, this may be true, the same can be said about the stock market.
Yes, in general, houses will appreciate, especially those in prime locations where space is scarce. But there bubbles do occur. Who knows if we are in one now? You could buy a house today, only to see the market crash and not recover its full value until ten years later.
I think when it comes to real estate, like with stocks it’s important to understand the following:
No matter what “the market” looks like, there are always great offers out there. Even in a bear market, there are companies thriving and houses or apartments with tremendous potential. If you are serious about investing real estate, do your research. It’s not easy, but you don’t need to be an economics graduate or a trained professional to spot a good opportunity.
Advantages of Stocks
I have talked a lot about stocks before. They are a great investment vehicle, and thanks to technology, they are available to everyone.
Here is a summary of their main advantages.
Stocks are Liquid
Stock markets are very developed, and thanks to this stocks have become an extremely liquid asset. A publicly traded stock can be sold pretty much instantly. This is good if you are in need of some extra cash.
Stocks can Outperform Real Estate
Real estate is somewhat straight forward; there’s a house with a certain size, characteristics, and location. This house can be rented or sold for so much and this determines the value. With stocks, the story is much different. Each stock represents a different company, some stocks represent companies which are innovative and are changing the way we do business. It is these stocks that can get you the highest returns. Some companies can achieve growth rates of 30 or even 50%.
Stocks and other equities such as ETFs can help you have a more balanced and diversified portfolio. With real estate, especially if you are buying a house with a mortgage, you are putting all your eggs (and a substantial amount of them) in one basket. With stocks, it is much easier and less expensive to diversify your portfolio and be more resilient to bad times.
Disadvantages of Stocks
But stocks can also have some disadvantages.
Stocks are much more volatile than real estate. While you can make 20% in a year you can lose just as much, or more.
Furthermore, because of the nature and ease with which stocks can be bought, it is easy to end up making emotional and irrational decisions. You must be able to keep a level head if you want to succeed in the investment game.
This is pretty much all I can say about stocks and real estate. All that’s left to answer is. What is the best decision for you?
That really depends, as it always does, on your personal financial goals and risk appetite.
Like I’ve said before, I would think very hard about buying a house by getting a mortgage. This isn’t really investing, as you are getting into debt.
However, there are some great alternatives if you want exposure to the real estate market without so much commitment.
Real Estate Investment Trusts (REITs) can do just this for you. These are trusts you can easily invest in to gain exposure to the real estate market. They take the money from all their trustees and buy different properties. So you do not own an actual property, but rather a percentage.
There are even ETF’s that track the performance of real estate.
Some people like real estate, they know the market better. Some prefer stocks. If you have or can acquire specialized knowledge on any of these, by all means, go ahead an use it.
But overall, I think a well balanced portfolio should have a bit of both.
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