To grow your wealth, which is the better strategy? Investing in real estate or building a portfolio of stocks?
If you’re looking to double down on either type of investment – or you’re just new to investing in general – it’s wise to know the advantages and disadvantages of each strategy. It’s also important to know you don’t necessarily have to choose between the two. You can purchase shares in real estate investments without the headaches of actually buying, managing and selling properties.
Ed Rempel is a fee-for-service financial planner, award-winning blogger, and podcaster based out of Canada. To date, he has developed many financial plans and has shared his unique insights into finance across the areas in various forms, including his blog, his podcast, and through his YouTube channel.
Today, he weighs in on the complex question of whether you should invest in stocks or real estate.
Investing in real estate
Traditional real estate investments can be broken down into two broad categories: typical residential properties, AKA your home, rentals, or flipping homes to buy, then resell for profit; and commercial real estate properties, such as apartment complexes, office buildings, and strip malls.
“Investing in real estate is easier to understand than stocks, because they are physical objects we can see” explains Rempel. “While the homebuying journey can be pretty complicated, the basics are simple: purchase yourself a property, manage the upkeep, and attempt to resell it for a higher value.”
Also, owning a tangible property can make you feel far more in control of your investment than buying slivers of ownership in companies through shares or stocks.
“Investing with debt is necessary to make real estate investing a good return,” says Rempel. “Also known as your ‘mortgage’, you can invest in a new property and finance the rest of the property’s cost.”
Real estate investments can serve as a hedge against inflation as well. Real estate ownership is generally considered a hedge against inflation because home values and rents typically increase with inflation.
Real estate investments can be a lot more work than traditional stocks. While purchasing property is easy to understand in theory, that doesn’t mean the work of maintaining properties, especially rentals, is easy. Owning properties requires much more sweat than purchasing a stock or stock investments, such as mutual funds.
“Real estate is expensive and highly illiquid,” says Rempel. “Investing in real estate, even when you’re borrowing cash, requires a large upfront investment. Getting your money out of a real estate investment via resale is far more difficult than the point-and-click ease of buying and selling stocks. That’s something to consider.”
It’s important to remember that real estate has high transaction costs. A seller can expect to pay a significant amount of closing costs, which can take as much as 6% to 10% off the top of the sale price. That can be a hefty cut compared to stocks, especially considering that most brokers charge no fees for stock trades.
“It’s difficult to diversify your investments when it comes to real estate. Owning several properties that are all residential real estate in the same city is not diversified at all. Location matters when it comes to investing in real estate,” says Rempel. “Sales may slump in one area, while values may explode in others. Diversifying the purchase or real estate properties by location and type requires a lot deeper pockets than the average investor has.”
The return on investment isn’t a promised thing. While property prices tend to rise over time, there’s always a risk of selling a property at a loss.
Investing in stocks
“Buying shares of stocks has significant pros – and some cons – to remember before you take the plunge,” says Rempel.
The stocks are highly liquid. While investment cash can be locked up for several years in real estate, the sale and purchase of public company shares can be done at the exact moment you decide it’s time to act. Unlike real estate, it’s also easier to know the value of any of your investments at any time.
“It’s much easier to diversify your portfolio with stocks. Few people have the time, let alone the cash, to purchase enough real estate properties to cover a range of locations or industries to have true diversification,” says Rempel. “With stocks, it’s easy to build a broad portfolio of companies all over the world and in many industries at a fraction of the time or cost of owning a diversified portfolio of properties.”
There are fewer transaction fees with stocks. While you will need to open a brokerage account to buy and sell stocks, the price war amongst discount brokers has reduced stock trading to the cost of zero in some cases. Many brokers also offer a selection of no-transaction-fee mutual funds, index funds, as well as EFTs.
“Stock prices are more volatile than real estate,” says Rempel. “The prices of stocks can move up and down far faster than real estate prices short term, but solid long-term returns after inflation are actually quite reliable. The volatility can be sickening unless you take a long view on the stocks and funds you purchase for your portfolio, which means you plan to buy and hold despite volatility.”
Selling stocks can result in capital gains tax. When you sell stocks, you may have to pay capital gains tax generally speaking. Also, you would have to pay taxes on any stock dividends your portfolio paid out during the year. Stocks can trigger a lot of emotional decision-making. While you can buy and sell stocks far more easily than real estate properties, that doesn’t always mean you should. When markets waver, investors often sell when a buy-and-hold strategy usually produces greater returns. Investors need to take a longer view of all investments, including when it comes to building a stock portfolio.