If your goal is to grow wealth, which is the better investment: real estate or stocks?
The answer: It depends. A mix of both may be the right choice for you.
Many Americans already have exposure to real estate and stocks, considering that 65% of households are owner-occupied and 55% of Americans participate in their employers’ retirement plans.
How you invest is ultimately a personal choice based on your finances, short- and long-term goals, and risk tolerance. Whether you’re new to investing or a seasoned veteran, it’s essential to understand the pros and cons of each type of investment to make decisions with confidence.
Investing in Stocks: Pros and Cons
One of the most appealing aspects of investing in the stock market is making a significant amount of money in a short amount of time. But although the rewards can be great, these types of investments are not without risk, either.
Pros of Investing in Stocks
- You can build wealth without a lot of start-up money. The stock market’s average annualized gains are close to 10%. If you stay the course and tolerate the ups and downs of the market, you could amass a significant amount of wealth over time. You don’t need a large amount of cash to purchase stocks, either. Look into an exchange-traded fund (ETF) or exchange-traded product (ETP) to get started.
- Stocks offer multiple ways to invest. For example, are you looking to leverage short-term trends with a riskier buy low/sell high day trader’s approach? Or hold stocks for the long-term as the company’s earnings grow over time? An advantage to stocks is there’s no one right way to invest. New investors might even hone their trading skills by practicing with a market simulator before risking their own money.
- Stocks are highly liquid. You can sell stocks instantly, usually with minimal transaction fees, should you need quick access to your money. However, picking the right time to sell can be tricky. Be aware of market fluctuations to avoid taking a loss.
- It’s easy to diversify with stocks. Diversifying your portfolio will reduce your risk. Mitigate your exposure with a mix of well-diversified stocks, bonds, and commodities and invest in large, mid, and small-cap companies in various stages of growth. Consider emerging markets in Europe, Asia, and South America to diversify your holdings further. You can also use tools like Motley Fool to find the best stocks to invest in.
Cons of Investing in Stocks
- The only “sure thing” is market volatility. Stock prices will rise and fall dramatically, and year-over-year returns aren’t guaranteed. It’s a long game that takes patience and restraint to ride out the market when it dips or even crashes. Invest the money you won’t need for at least 5-10 years at a minimum, so you can weather those course corrections without panicking.
- You could lose your investment. Knowing how to choose the right, profitable companies takes a commitment of time to research to understand what you’re investing in. And investments still don’t always work out. For example, if a company goes bankrupt, stockholders are the last to be paid, if at all.
- Know the tax implications. Selling your stocks may trigger capital gains tax, although stocks held for less than a year could be eligible for a lower rate. You may also need to pay taxes on any dividends that are paid out on your portfolio. So it’s important to know how stocks may affect your tax bill.
- Prepare for emotional ups and downs. Inexperienced investors often react by selling off assets when the market becomes volatile. However, experienced investors know the more prudent approach is keeping their holdings and riding it out to see a greater return in the long run.
Investing in Real Estate: Pros and Cons
Investing in real estate adds diversity to your portfolio and reduces your risk exposure. In addition, whether residential or commercial, real estate is generally a solid long-term growth strategy.
Pros of Investing in Real Estate
- Real estate can provide steady income: An investment property may not only provide capital gains if you purchase a property to renovate and flip, but it can also provide passive income if used as a rental property.
- Real estate provides leverage power. You can grow your real estate holdings by using leveraged debt to increase your buying power, allowing you to expand your portfolio exponentially faster. If you’re considering buying more investment properties, know the rules and tax benefits of a 1031 exchange.
- Know the tax advantages. Real estate has several distinct tax benefits, including deductions for mortgage interest and tax breaks for real estate investors, including depreciation, which allows you to deduct the cost of a property over 27.5 years.
- Real estate is a hedge against inflation. Historically, rents and home values will rise with inflation, but remember, a fixed-price mortgage payment does not, keeping cost-of-ownership steady.
Cons of Investing in Real Estate
- You need money to start with. Real estate requires an upfront investment of down payment, closing costs, and possibly repair and renovation costs to update a rental property. Don’t forget to factor in ongoing expenses such as repairs, taxes, insurance, and maintenance costs as well. And when you sell a home, you have to take a portion out of the selling price for real estate commission.
- Rental properties must be managed. Whether you do it yourself or hire a property manager, the day-to-day maintenance of a short- or long-term rental takes time and active management, which some investors might consider a headache.
- Real estate isn’t liquid. Unlike stocks, which can be sold at any time, selling real estate takes time and patience, especially if you choose to sell it without a real estate agent. It could take weeks or months to unload a property from your portfolio, which is inconvenient should you need fast access to your money.
- Real estate is difficult to diversify. Opportunities for diversification are limited to location and types of residential or commercial properties. You might consider diversifying with REITs or real estate investment trusts, which offer hands-off investing with companies that own and sometimes manage income properties such as apartment buildings, warehouses, hotels, and malls.