Many people wander what is the best asset class to invest money in that won’t be touched for a long time, usually at least a decade. Unless you have the capital and skillset to invest in a private business or start your own business, the best options come down to two asset classes, stocks and real estate. You will hear vigorous arguments on both sides about which one is better. If your family has owned Phillip Morris stock for 50 years, you would feel strongly stocks are the way to go. If your family has owned an office building or apartment in Manhattan or San Francisco for 50 years, you would certainly think real estate wins hands down.
My opinion? It depends. Numerous factors apply including temperament, personality, risk tolerance, liquidity needs, work ethic and personal goals.
Temperament plays a big role in both asset classes, but is EXTREMELY important for stock market investing. As has been said many times before most notably by Warren Buffett, if you can’t stand to see your positions decline by 50% (or even more) from time to time don’t even think about investing in stocks. All of financial history has been encompassed by periods of booms and busts. Speculative manias will happen, and depressing crashes will happen. The investor who can calmly and rationally evaluate earnings, dividends, balance sheets and most importantly valuation and can act on those calculations will most likely do very well investing in stocks. Conversely, if someone gets nervous and antsy about seeing a 10% stock market decline and have thoughts about selling out and cutting losses, they will not likely do well in the stock market.
Someone that struggles with constantly quoted asset prices and can’t stand to see paper declines in wealth may be better suited for investing in real estate. There are frequent quotations for real estate, and many people find this appealing whether they know it or not. That said, temperament is still important in real estate investing. If you own rental properties there will be several surprises along the way, some of them unpleasant. Even if you hire a property manager, (which I would highly recommend) you will still have some unexpected maintenance expenditures or vacancies. These pop up from time to time and should be properly budgeted for.
If you are the type that has an outgoing personality, you may find real estate investing much more appealing. A big key to real estate investing is networking through brokers, property managers and other investors. Also, successful real estate investing involves surrounding yourself with the right team. This would consist of a broker, property manager, accountant, repairman, and a real estate lawyer just to name a few. Your success as an investor will partially depend upon your ability to work with your team. Finding and assembling the right team will take time, but will help give an investor less hassle and higher returns.
One of the big debates is whether stocks or real estate is riskier. We have already talked about price fluctuations in stocks which some may or may not view as risk. Many people would rather have control and be hands on with their investing and not entrust their capital to a management team they haven’t met. There is certainly some merit to this line of thinking. Some people would like to be able to make all the decisions. If that’s the case, real estate investing will provide for a entrepreneurial management style. On the other hand, if you think risk is having a lot of outstanding bank loans and would prefer to own things on a cash basis and not finance anything, stocks would be preferable provided no margin debt is being used.
One huge advantage for stocks is the ability to be able to quickly convert holdings to cash should the need arise. This is known as liquidity. Real estate can take months or even years to sell. Although stocks can be readily sold, you would be wise to only invest money in an individual stock or index fund that you plan to hold at least five and better yet ten years down the road. With real estate if you find yourself in a sudden liquidity crunch there may be some options such as withdrawing some of the equity built up in the property, or a line of credit. Those options can be difficult in times of economic distress due to banks wanting to shore up their own balance sheet.
Someone who is a successful stock or real estate investor must have a strong work ethic. Constantly being on the lookout for successful deals takes time and discipline. If you have a team of brokers sending you potential deals, it makes it much easier to find a great one. After that, you must qualify each deal by underwriting them fully before making an offer. This means verifying the rents and expenses and calculating the Net Operating Income. If your offer is accepted, you must then undergo the due diligence process which may take several months and you will be spending lots of time verifying the seller’s income and expenses, searching for the best insurance policy and finding a property manager, as well as many other tasks. These can be shortened if you already have a team in place but will still require a lot of effort. After purchasing the property, you will still have to keep updated records as well as visit the property from time to time. If you decide to self manage, you better have a very strong work ethic because you may have just bought yourself a part time job, depending on the size of the property. Some people may enjoy self managing, so it really depends on the personality type.
Conversely, if you do not have a lot of spare time due to being a young professional who works 60-70 hours a week or you are married with young children, stocks can be more appealing due to being more passive in nature. When I say passive, I am talking about an index or mutual fund that someone other than the investor manages. If an investor wants to invest in individual stocks and do it properly by reviewing income statements, cash flow statements, balance sheets, 10k’s etc., then that will also take a very strong work ethic, as well as a lot of time. I would only recommend this option for someone with the aforementioned temperament requirements as well as a good understanding of accounting and finance. For someone who doesn’t have enough time, or just wants exposure to the stock market with little effort then buying a stock index fund would be the best option.
The whole point of investing is to outlay money today for a higher inflation-adjusted sum of money in the future. Both real estate and stocks will accomplish this goal if done properly. If your goal is current income, real estate investing is hands down the best option. If your goal is a long term (i.e. 25+ years) building of net worth, I would give the edge to stocks, although a case can certainly be made for real estate.
History would show that nothing matches the stock market for wealth creation. Not bonds, gold, real estate, or cash. $1 invested in the stock market 100 years ago would grow to ~$5,500 or $13,800 depending on whether or not dividends were reinvested. That said, no one lives long enough to see those returns, nor would they want to wait that long. If you are a great real estate investor and are comfortable using lots of leverage, you can make very high returns in a short amount of time. It is not uncommon for a great real estate investor to buy a distressed property, turn it around, and sell for a massive gain two to three years down the road making 3-4x the initial investment. It is very difficult to make that kind of return in the stock market, in that amount of time. Professional traders may be able to pull it off, but it is not easy or likely due to the effects of leverage.
Both asset classes are great for wealth building. I personally have exposure to both and will continue to do so. There is no single “right way” to invest money, it’s all about satisfying one’s financial goals.