My brother is a financial adviser, and while he has memorized the investors manifesto, I have to disagree with him on investing in stocks. First and foremost, I can’t beat the market. You can’t beat the market. If you don’t believe me, read about something called ‘a random walk‘ then try and convince me that you can beat a blindfolded monkey at picking stocks.
Anyways, if you can beat the market, you’re already a bajillionaire and you’re not reading my blog. For the rest of us, let’s look at historical market returns (because that’s what we can get in the real world) as compared to investing in real estate. We’ll take $20,000 and invest it and see which yields the best return.
Let’s go with a 10% average return for the market (some would argue it’s 7%, but let’s be generous).
Real estate ranges anywhere from 3% to as high as 4.5%. My view (as an amatuer economist) is that housing is tied to inflation. In the U.S., demand for housing (not taking into account weird areas like Arlington where traffic congestion over the last 20 years has led to ridiculous rates of return) stays steady with supply, therefore any price increase is largely due to inflation. So we’ll go with a conservative number of 3.5%.
I take my $20k and put it in the market for 10 years and get my 10% return. The following algorithm can be used to figure out the final amount:
P = the initial amount
T = the % return
N = number of years
20,000(1+.1)^10 = $51,874.
If you don’t trust my math, check it out below (don’t be a theist, science and numbers rule)
| Year | Return | Total |
|---|---|---|
| 1 | $2,000 | $22,000 |
| 2 | $2,200 | $24,200.00 |
| 3 | $2,420 | $26,620.00 |
| 4 | $2,662 | $29,282.00 |
| 5 | $2,928 | $32,210.20 |
| 6 | $3,221 | $35,431.22 |
| 7 | $3,543 | $38,974.34 |
| 8 | $3,897 | $42,871.78 |
| 9 | $4,287 | $47,158.95 |
| 10 | $4,716 | $51,874.85 |
Not too shabby.
However, let’s take a look at real estate. For $24k I can put 20% down and buy a $100,000 rental home. I’m figuring $4,000 in miscellaneous fees and other closing costs. My loan is at a conservative 6% rate, reflective of today’s low rates. My property tax is 1.25% and my PMI is 0 because I put 20% down.
My monthly payments are $583.81 of which I pay $400 in interest the first year and an average of $300 over the 10 year span.
My equity at the end of 10 years is: $100,000(1+.035)^10 = $141,059.
Next I can deduct the mortgage interest each year: that’s $300(average / month) x (12 months) x 10 years x 30% (my actual tax deduction) = $10,800.
Furthermore, I’m renting it out at a fair market rate of $600 / month minus expenses and vacancy for an actual rate of $200 / month: $200 x 12 x 10 = $24,000. We’ll go ahead and tax that rental income at 30%, so you actually get $16,800.
At this point I’ve made $41,059 in equity + $16,800 rental income + $10,800 in tax deductions = $68,659.
Not too shabby! But I’m not done bashing stocks over the head yet, come on stocks, get up off the floor so I can slam you one more time…
We have to sell these assets at some point in time to get cash (except for my rent checks of course). Capital gains on stock money is currently 15% – that leaves me with $44,092. I’m going to declare my rental house as my primary home and pay no tax on it when I sell it. I’ll pay 3% to the buyers agent because I’ll sell it myself, which leaves me with: $36,827 from the sale.
To sum it up:
Stocks: $44,092 with a 10% return on $20k for 10 years.
House: $64,427 with a 3.5% equity growth, $24k down on a $100k investment property.
Lastly, if you’re like me stocks are simple – you invest cash in no fee mutual fund and let it grow without ever thinking about it. Real estate is messy. You have to get your hands dirty and you have to deal with dead beat tenants. If you don’t mind it, you can make a lot more money… greed is good 🙂
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