In today’s post, we’re going to settle the great debate once and for all – and that is the answer to one question:
Which is the better investment – stocks vs real estate?
Read until the end of this post for the pros and cons of both, and our opinion as someone who has invested and advised people in both asset classes.
It’s no secret that real estate investing has created 90% of the world’s millionaires.
And right now, there are over $95 trillion dollars invested in the stock market, which is a whole lot of money.
Which is Better- Stocks vs. Real Estate Investing?
So which is better between stocks vs. real estate investing? We’re going to look at several areas to determine this such as:
- Income from Dividends or Cash Flow
- Tax Advantages
- Ease and Simplicity
So let’s start with appreciation.
It basically means that the asset you invest in will increase in value over time.
Both, stocks and real estate appreciate in value. But one more than the other.
According to Business Insider, the stock market has appreciated almost 3x as much as the housing market since the 08 recession.
Appreciation is a very important factor when you determine what asset you invest in because it allows you to take advantage of compound interest.
Appreciation is why billionaire investors like Warren Buffet recommend investing in stock funds like the S&P 500 as the single-best stock investment for most people.
For example, the S&P index fund, which is composed of 500 of the largest companies in the United States, had an average annualized return of 10% since its inception in 1926.
Because of compound interest, this means that your money would double in 7 years at this rate.
So if you invested $100,000 today, you would have $200,000 in 7 years, and $400,000 in 14 years.
Or let’s say you’re starting with absolutely nothing right now…
…if you started investing $1,000 per month with a 10% growth rate, you would have over $1.3 million dollars in 25 years.
That’s how powerful compound interest and appreciation is. And historically speaking, the stock market has appreciated more than the real estate market.
So that’s 1 point for the stock market.
Both, stocks vs. real estate investing can provide consistent income to you as an investor.
In the stock market, income is paid to you in the form of a dividend. There are stocks with very high dividends, and some stocks that do not pay dividends at all.
If you invest in a group of stocks, like the S&P 500 for example, then you would receive an average of all of the dividends paid out from that group.
Historically, the S&P 500 has paid a dividend yield of about 1.88% per year, which is about $1800 on a $100,000 investment.
This isn’t life-changing if we’re being honest, but to be fair, you can invest in stocks with higher dividends, but those typically appreciate less in value.
On the other hand, when you invest in real estate, income is paid to you in the form of cash flow from rent.
Typically, real estate investors will make at least 8-12% in rental income on their cash investment.
And we’ve even seen returns as high as 15-20%.
Now, of course, there’s the argument that there is a lot of work in real estate investing and it certainly can be, but it doesn’t have to be.
Especially not today.
These days, you can easily passively invest in real estate through platforms like Fundrise…
…or CrowdStreet and let someone else do all of the work for you.
Or you can buy properties and hire a really good property management company to manage your property for you.
So ultimately, when it comes to passive income, real estate investing wins by far.
So let’s give real estate 1 point on our scoreboard here.
Now we’re tied up.
3. Tax Advantages
So let’s take a look at the tax side of things – our favorite part of the equation by far.
When you invest in stocks, you only pay taxes when you sell your stocks, not when it increases in value.
When you sell your stocks, you would pay either short-term or long-term capital gains. And this is treated very differently for tax purposes.
Short-term capital gains are taxed just like your ordinary income, which is the highest type of income tax that exists. Ordinary income tax brackets can range from 0-40%.
While on the other hand, long-term capital gains are taxed at a much lower rate, which can range from 0-20%.
So how do you pay long-term capital gains tax on your stocks?
It’s simple – all you have to do is hold your stocks for more than 1 year and you can take advantage of the lower tax rate.
This means if you’re day-trading and buying and selling stocks every day, you’re going to pay short-term capital gains taxes, which is much higher than long-term capital gains.
So there are some tax advantages of investing in stocks, as long as you hold your stocks for a longer period of time.
Now, let’s take a look at the tax advantages of real estate.
The tax advantages associated with real estate alone may single-handedly make real estate the best investment of all time.
You can literally earn money tax-free, and even avoid taxes legally.
You can take advantage of the depreciation, which works like magic, because it allows you to claim an expense for something that does not cost you any money.
It’s the only tax deduction that can lower your income without actually costing you a dollar.
So hypothetically, you can earn rental income from real estate and report a loss to the IRS after claiming depreciation.
And this isn’t a tax loophole, it’s literally a part of the tax law.
The government wants to provide affordable housing and wants to encourage people to invest in real estate.
They even allow you to accelerate the rate of depreciation expense you take on your real estate investments.
Check out this post next to learn more about real estate depreciation.
But what happens when you sell the property?
Technically, you would pay capital gains tax on your property when you sell it, just like a stock.
But fortunately, there’s this tax code called the 1031 exchange.
The 1031 exchange allows you to sell one property without paying capital gains taxes, as long as you buy a similar property.
It’s kind of like you’re “swapping” one investment for another. But the beauty is in the fact that you can keep “swapping” into higher-value properties.
For example, let’s say you bought a $100,000 home. And 5 years later, the home is worth $150,000, so you decide to sell it.
Well now, when you sell it, you have $50,000 more than what you paid for it. Now you can buy a $150,000 property and not pay any taxes on that gain.
You’re effectively growing your wealth, but you aren’t paying any taxes to grow your wealth.
This is why we love real estate investing. Here’s our post on 1031 exchange explained that you can read after.
If you sell a stock in the stock market, you’re going to be taxed on it even if you buy another stock.
The tax code highly favors real estate investing, and a lot of millionaires use it to pay little to no taxes at all.
And by the way, taxes are the single greatest expense that most people will pay over the course of their lifetime.
So by mitigating this, you can grow your wealth exponentially.
Let’s go ahead and give real estate a point here.
Now for this stock vs. real estate investing debate, let’s bring everything together here and address some of the elephants in the room.
In general, real estate has a higher return than stocks when you consider all things – tax savings, cash flow, and appreciation.
This is why 90% of millionaires invest in real estate.
However, there are some non-financial reasons why people decide not to invest in real estate or stocks that are worth mentioning as well here.
So let’s address it.
Real estate is an illiquid asset. Once you invest in real estate, you cannot get your money out of it easily.
So if you invest in real estate, the only cash you can rely on is the cash flow coming in from rental income.
And if that’s not enough, then you might find yourself in a very uncomfortable situation.
Stocks, on the other hand, are very liquid. If you need your money now, you can get it immediately.
This is very beneficial in the case of an emergency or you find out that you need to make a big purchase.
So let’s give stocks a point for liquidity.
Now, we should also mention that liquidity can be a double-edged sword.
You generally do not want to interrupt the compounding nature of your investments.
Or make emotional decisions that cause you to panic sell or panic buy something.
Whenever you invest, it should be for the long-term.
Both, stocks vs. real estate investing, operate in markets and these markets go up and down over time.
And you don’t want to find yourself selling assets in a downturn.
So regardless of what you invest in, we’d suggest making sure a small % of your portfolio is liquid in cash or another asset that you can rely on when needed.
Stocks are intangible assets.
You can’t touch or feel it. Its value is driven up when people buy the stock and it can crash down if everyone sells the stock.
This is a major risk of investing in stocks.
If the companies you invest in fail, then you could lose all of your money with nothing to show for it.
Now, of course, you can mitigate this risk by investing in a diversified portfolio that includes a lot of quality companies.
However, the fact of the matter is that it is still an intangible asset and the entire market can crash & leave you with nothing left to show for your investment.
Whereas with real estate, on the other hand, you are investing in a real, tangible asset.
Even if your rental business fails, you still have a tangible asset that is going to be worth something at the end of the day.
With that said, let’s give real estate a point.
6. Ease and Simplicity
Real estate investing can be overwhelming, especially if you’re going at it alone.
You have to save up cash for a down payment, take out debt to buy the home, and take care of the home, which can require a lot of work.
Now, you can simplify this by passively investing in REITS or private equity.
However, you still need to understand the nuances and risks associated with those types of offerings.
Whereas with stocks, it’s pretty straightforward.
You can make a deposit and buy a good index fund in an instant. And then your money is working for you on auto-pilot.
You don’t even have to think about anything as long as you construct your portfolio correctly.
You can even set up automatic transfers to buy stocks every time you get paid from work or your business.
So let’s give stocks a point for ease of use.
With stocks, you are not in control of what happens to your investment.
The stock market is like a roller coaster and you have to know how to ride it.
If you invest in individual stocks, the company could make one wrong decision that leads to a massive sell-off that crashes your investment.
And even if you invest in highly diversified mutual funds, the entire stock market could still crash due to a few headlines that have nothing to do with the businesses you’re invested in.
All it takes is a few downturns for you to realize how volatile the market is.
Like history says the stock market has gone up over time, but does that really mean that it’s going to go up forever?
For instance, what would happen if everyone just pulled all of their money out of the stock market right now?
That would be a disaster, right?
It’s the complete opposite with real estate.
Once you close on that property, it’s yours. You can do whatever you want with it.
You control the prices you charge, the tenants you accept, and the strategies you deploy to build wealth.
Real estate is just more stable and controllable at the end of the day.
So let’s give real estate a point for control.
Stocks vs. Real Estate Investing: The Winner
So the final scoreboard here is 4-3 in favor of real estate.
This means real estate would be the better investment vehicle in our opinion.
The overall returns are undeniably better once you factor in tax savings, and we personally like the stability of the market in comparison to the stock market overall.
Diversify your Portfolio
But whatever you invest in, always keep in mind that diversification is very important.
You shouldn’t just diversify across different sectors in the assets you buy, but you should also diversify across different types of assets out there.
We love real estate investing, so our portfolio leans that way.
But we also invest in stocks, and even throw a few coins at crypto sometimes.
Diversification is never a bad strategy when it comes to investing.
But hopefully, this post helps you understand some of the pros and cons between stocks vs. real estate investing.
If you want more tips to lower your taxes and increase your wealth, get our wealth management services today!