The Stock Market Versus Real Estate: Which Investment Is Better?

real estate investment

I was 22 when I completed my general classes in school and began signing up for finance and business classes. At that point, I owned a home that was increasing in value. I loved real estate already and wanted it to be part of my career.

As I sifted through the Metro State program in Denver, I realized that there weren’t any classes on investing in the real estate market. The only investing classes that I could find were on stocks. Why is that?

I took a class on investing in the stock market. While I understood the concepts, I did not enjoy it. The stock market class was crazy.

We got bonus points for how well our phantom portfolio performed over the semester. I finished dead last because I invested in some oil future options. I thought if I could grasp the concept of a future option, I would understand both futures and options. That risky play wiped me out of contention. I learned a valuable lesson in that class: stocks can be a bit… unpredictable.

I later took a financial planning class, which gave me a bit more flexibility, and I focused on real estate investing. I received the highest grade in the class, with praise from the professor for my presentation on “Protecting Your Real Estate Portfolio.” I still remember the day when he told me how much he learned from me that year.

In the end, I realized that real estate investing is much more reliable and less volatile than the stock market. By the time I received my degree two years later, I was already working in my dream job, building my real estate portfolio.

Return On Investment In Real Estate And The Stock Market

I can tell you from personal experience that getting involved in the stock market is pretty simple. Moreover, as long as you’re not trying to time the market or outsmart the professionals, it can be easy to maneuver as well. However, most people only have a vague understanding of what stocks are and what the stock market is.

A stock is an ownership in a company. For example, when you purchase a stock in Apple, you are purchasing a small piece of that company. If the company does well, you will do well. If the company does poorly, you will too.

The profits of a company do not drive the price of a stock, as you might think. Rather, the value of the stock is driven by supply and demand. If lots of investors believe in the potential growth and success of a stock, it could drive demand up and therefore increase the price of the stock.

Most public companies trade stock on a public market or “exchange” – which is commonly known as the stock market. Because the stock market is so big, with millions of buyers and sellers, there is liquidity. This means there is always someone willing to sell you a stock or buy a stock from you, at the right price.

On the other hand, there is a reason more millionaires either made their fortune or hold their wealth in real estate than any other investment type. Real estate can provide the cash flow an income-seeking investor is after, as well as the upside of appreciation that stocks have. As such, I truly believe that real estate is an investment worth looking into.

The Risks Of Investing In The Stock Market Versus Real Estate

I can’t emphasize enough the importance of understanding the risks of investing. Whether you’re investing in real estate or the stock market, the risk of losing money will always be present. Although recognizing the risks can help you mitigate them, you need to understand that unforeseen circumstances are likely – and they can affect your investments.

For instance, the banking crisis of 2008 and the COVID-19 pandemic had a significant impact on both the real estate market and the stock market. Many people were caught off guard by these events, and experienced the immense financial impact of them.

Risk is always a factor to consider when investing, regardless of the type of investment you choose. It’s important to be aware of this risk, and how it can affect your financial situation. The following are some of the specific investment risks you should know about:

  • Inflation risk: This is the possibility that the purchasing power of your investment will decrease over time if it does not keep up with inflation. Whilst real estate and stocks tend to increase in value over time, inflation can negate that increase. Inflation can therefore undermine the value of your investment.
  • Interest rate risk: If interest rates rise, it can lower demand for real estate because fewer buyers will be able to afford a mortgage. Moreover, when interest rates go up, it tends to reduce demand for stocks since buyers usually cut back on spending during these times, causing stock prices to decrease.
    Additionally, if you’ve borrowed at a fixed rate and the interest rate falls, you’ll end up paying more than the market rate. However, that’s a risk you take for any kind of loan you take out.
  • Political risk: Changes in government policy can have an impact on investments. For example, changes to capital gains tax exemption laws could negatively impact your ability to generate a profit.
    If capital gains taxes increase or the threshold goes down, you could end up paying more tax on your capital gains, thereby reducing your potential profit should you decide to sell any of your stocks or real estate holdings.

Like I tell everybody, there’s always going to be risks associated with any investment, and there’s no guarantee that you won’t lose money. However, if your portfolio of investments is diversified and you invest for the long term, you can weather the ups and downs of the market and still come out ahead.

When it comes to investing I suggest weighing the pros and cons, whether you’re looking at the stock market or real estate.

Investing In The Stock Market

Although the stock market certainly offers investors a real opportunity to find success, I believe it’s crucial that you understand both the benefits and drawbacks of investing in stocks.

With that in mind, the following are some of the noteworthy benefits and risks I think you should be aware of if you plan to invest in the stock market.

The Benefits Of Investing In The Stock Market

Arguably the most traditional way to invest in the stock market is by buying stocks. However, there are countless other ways to invest as well, such as by investing in bonds and funds. Whichever option you choose, investing in the stock market has many benefits. The following are some of the main reasons why people choose to invest in the stock market:

  • High liquidity makes trading easy
    The most significant benefit the stock market has over many other investment types is that it is 100% liquid. Liquidity refers to how easy it is to turn your investment into cash. Some investments are not liquid at all, with minimum investment periods. Some investments may need some time to sell, and some you can sell with the push of a button. Liquidity is a big benefit of investing in the stock market. You can use a stock account as a reserve and get access to the cash quickly if you need it. Not to mention that you can get out of a stock investment quickly if you need to as well.
  • It’s easier to diversify stock investment
    One of the great things about investing in stocks is that you can take risks, play it safe, or even do both. That’s because you can own stocks in different companies and different industries, thereby diversifying your investment and limiting your risk.You can also buy bonds, which are a safer investment. Bonds are debt instruments issued by companies or the government. When a large company or government wants to borrow money, they can sell bonds to investors. This debt is safer than equity because it gets paid back first.This is because debtholders have priority over shareholders if the company goes bankrupt. Bonds typically come with an interest rate, so the return is predictable unless you need to sell. Many investors use a mix of stocks and bonds to balance their stock portfolio.
  • Determining the value of your stock market portfolio is simple
    Your stock market account is easy to value. Stock values shift constantly, but at any given moment you can determine the current value. It’s easy to access all the details of your stock market investment by simply logging in to your brokerage account. I have found that knowing asset values helps to plan for any future investments.
  • The transaction fees are lower
    Low fees are a huge advantage. When trading stocks, you’ll be charged trading fees by brokerage houses, but these transaction fees are usually low (depending on which brokerage you choose).If you go with a bigger brokerage house like Charles Schwab, you may pay a little more but you can get access to benefits such as stock advice, banking, and PALs. Alternatively, you could go with a company like TD Ameritrade and save on fees.Another option is to buy into a fund. A fund offers a way to own multiple stocks and/or bonds in one singular investment. Buying into a fund can be a great way for beginners to invest in the stock market because you have someone else managing it for you.There is a fee for managed funds but fund fees are relatively small. If you are trying to save on fees, you should consider Exchange Traded Funds (ETFs) over mutual funds.
  • Investments in tax-advantaged retirement accounts can grow
    Stocks and real estate investments are also available in certain tax-advantaged retirement accounts, such as a 401(k) or an IRA (to hold real estate in a retirement account, you’ll need a self-directed IRA).These accounts offer different benefits, but both can help you grow your investment while deferring or eliminating taxes on the investment gains.

The Drawbacks Of Investing In The Stock Market

Despite all of the potential advantages of the stock market, there are a handful of potential drawbacks that you should be aware of as well. These possible risks include:

  • It’s more volatile and riskier than real estate
    Stocks can be challenging to understand. I see stocks fall and rise all the time, for reasons no one can explain. Like the time the car rental company Hertz’s stock price went up in value when they declared bankruptcy.How can you analyze a stock when this happens? Because of the unpredictable nature of the stock market, investing in individual stocks feels a lot like gambling. That is why I suggest most investors stick to funds.
  • Capital gains tax
    When you sell your stocks for a profit, you’ll owe capital gains tax on the sale. Long-term capital gains tax rates are lower than income tax rates, but they’re still a significant expense. Expect to pay up to 20% of your long-term gains in taxes, depending on your income bracket.However, if you hold your stocks for less than a year before selling them, your gains will be considered “short-term” and they will be taxed like regular income.
  • Emotional decision making
    When the stock market is going up, it’s easy to get caught up in the hype and start buying stocks without doing research. Similarly, when the market is going down, it can be tempting to sell all of your stocks in a panic. Investors who are driven to make emotion-based decisions often end up making bad decisions that can be costly in the long run.
  • Cash flow is limited
    In general, your stock accounts will not produce a lot of income or cash flow. Most stocks and most funds generate cash on capital gains, which refers to selling a stock at a higher price than you paid for it. If you need cash flow, you’ll have to sell – and if your stocks have dipped below what you paid for them, you’ll lose money.As such, you may improve your cash flow by selling, but you’ll lose money on your overall investment, which is the last thing you’ll want to do.One way to improve cash flow from stocks is by investing in dividend-paying stocks. A dividend is when the company pays out a portion of profits to its owners, thereby providing you with some cash flow. You can search for higher dividend-paying stocks and generate some cash flow and bonds this way.

Investing In Real Estate

Just like buying stocks, investing in real estate presents its own set of benefits and drawbacks. And just as with stocks, I always recommend that you carefully weigh the pros and cons before deciding on an investment strategy. Keeping this in mind, the following are the potential advantages and disadvantages of investing in real estate.

The Benefits Of Investing In Real Estate

When it comes to real estate investing, there are countless potential benefits – if you know what you’re doing. The following are some of the key benefits that I have experienced myself when it comes to real estate investing:

  • $0 down payment is possible
    I was broke with no credit buying houses while working and attending school. I learned to buy houses without down payments using tools like owner carry and hard money loans because I couldn’t afford a down payment. Investing with $0 down payment is possible, with some effort and the right team.However, you can leverage real estate more than any other investment. It’s why I tend to recommend making a down payment if you can afford to do so instead of trying to avoid it. For example, even without creative strategies, you can easily buy a rental with a 20% down payment. The big benefit of making a big down payment is that it can magnify your returns.For example, if you purchase a $100,000 house with a 20% down payment, you will have a cash investment of $20,000. If that house only increases in value by 5% in a year (well below a 30-year average), you will earn $5,000. That $5,000 in growth is 5% of the value of $100,000 but is a return of 25% on your $20,000 investment.
  • Rental properties generate income
    When you buy properties and turn them into rentals, it can generate enough rent to pay all your expenses and create some positive cash flow. Over time, you can potentially generate enough positive cash flow from your rentals to cover all your investment expenses. It takes several properties and time but it is achievable.You can also use the rent money to make the mortgage payment, so that each month your tenant pays a portion of the mortgage. Basically, your investment will be paying for itself!
  • It’s a great hedge against inflation
    Real estate is also a great hedge against inflation. The value of the dollar declines as the cost of living rises. In times of high inflation, tangible assets tend to do well. A property’s resale value as well as its rental income increase when inflation is high, so real estate usually does well during these times.
  • Tax advantages
    The largest tax break that real estate investors can have is depreciation. Depreciation is when you can deduct a certain percentage of the cost of the property each year. It is not an actual loss to the investor, but they get the benefit of a loss, which significantly reduces the amount in taxes they need to pay each year.
  • Real estate is essential and finite
    People need a place to live, and real estate is both essential and finite in that respect. Although rental and resale values can go up and down, they cannot go to zero, as we saw with the Enron stock. You can always rent a house out for something, and it will always be worth something.

The Drawbacks Of Investing In Real Estate

Although there are many potential advantages to real estate investing, there are a few potential disadvantages to take note of as well. These include:

  • Real estate requires more effort
    Becoming successful in real estate takes time and effort. Even if you hire a management company, there are still decisions to make and an asset to look after, and that takes time. Moreover, unlike a stock, it takes effort to locate the right property to buy, make the offer, and have it accepted.
  • Large upfront investment
    When it comes to the stock market, you can just use whatever money you have to buy stocks. Conversely, when it comes to investing in real estate, you need a significant amount of money to do so. Most people will have to take out substantial loans to invest in real estate. As such, real estate investing can be very expensive.
  • Lack of liquidity
    Unlike stocks, it is much more difficult to turn a property into cash. You typically need to clean it up, stage it, list it with a realtor, manage showings, wait for an offer, negotiate, wait for closing, and hope it all gets finalized. Real estate therefore lacks the liquidity that stocks have.
  • High transaction costs
    As I mentioned before, trading stocks generally only requires a small fee. Conversely, the transaction costs of buying and selling property can be way more expensive. You’ll need to pay commissions to your real estate agent, as well as closing costs, legal fees, and other miscellaneous expenses.
  • Difficulty in diversification
    All investments have some degree of risk, but these can be mitigated with risk identification and management, mostly through diversification.With stocks, diversification is done easily by buying into a fund. With real estate, diversification takes time and therefore carries an increased risk. You can reduce your risk by hiring good property managers, screening tenants, buying in good locations, and decreasing your leverage.However, certain factors, such as market conditions and natural disasters, are out of your control. Because buying real estate is a huge investment, it can be difficult to diversify into other properties, especially since real estate is often affected by the same factors.
  • Return on investment (ROI) is unstable
    If you compared a real estate investment to a stock investment at the end of a year, you might compare them by looking at your ROI. For a stock, it is easy. Simply look at what the stock is trading for and subtract what you paid for it, then add in any dividends and divide that number by your investment.For real estate, it is much more complicated and this typically makes the ROI much higher. But I want to point out that the ROI for real estate can be unstable.For instance, if you buy a rental property, you can’t foresee whether or not a tenant will stay and if it will be easy to find a new tenant. Real estate is generally a long-term investment, which means you may not see any profits for years. It’s also more difficult to predict.

Additional Factors To Consider

In addition to weighing the pros and cons of stocks and real estate, there are a few other factors that are worth thinking about as well. The following are a few factors that I think every investor should consider:

Control Of Your Investment

The amount of control you have over your investment is another factor to consider. With stocks, you have complete control over what and when you buy. However, you will have very minimal control over how the company operates.

At most, you’ll have some voting rights along with all of the other shareholders. Moreover, when investing in a fund, you have no control of what stocks are bought and sold – this is solely up to the manager of the fund.

With real estate, you will be giving up a lot of control as well. As soon as you sign a lease, you are giving the tenant control of your property. Unless they break the lease, they can use the home as they wish. Renting to a bad tenant can be very stressful, which is why I always make sure to have clear leasing terms. You will also give up some control when you hire a property manager but, in most cases, that is a good thing.

Time And Effort

I remember when I was learning about the stock market, I spent a ton of time on it. I watched the news and Mad Money on CNBC, trying to find the next Apple stock. It was very time consuming and frankly a little stressful. Although, investing in a fund does eliminate some of the time and effort required to manage your portfolio.

Real estate is similar to stocks – it takes a lot of time to locate and purchase a property. Finding properties to offer on, making offers, and negotiating deals can quickly become time-intensive. Moreover, once you have the property, more time and energy is required to get it ready to rent, find tenants, and so on. It also takes time to manage your property portfolio.

Investing, whether in real estate or the stock market, requires a significant commitment of time and energy. As a consequence, it may not be for everyone.

Market Research

Both stock and real estate investments require research. The output depends on how much effort you want to put into it.

To pick stocks individually requires intensive market research. It requires heavy reading and research to understand how the company operates, who operates it, and the strength of its financials.

Real estate also requires a lot of research to understand how to buy and invest, how to choose good locations, and how to pick a manager or team to oversee your property.

In both cases, it is easy to find support to get you the information you need, especially in real estate through realtors, lenders, and associations.

A Recap Of The Stock Market Versus Real Estate

When it comes down to it, stocks and real estate investments are very different types of investments that have different pros and cons. As the following chart shows, stocks are more volatile, more liquid, and easier to diversify. Real estate is more stable, less liquid, and less easy to diversify, but can provide a regular long-term cash-flow that stocks can’t.

Cash FlowCash flow when you sellRegular cash-flow
Management CostsBrokerage feesOngoing
Time and EffortResearch prior to investment plus routine check-insResearch prior to investment and diligent oversight plus regular interactions required
VolatilityStocks are volatile, prices can go up and down day-by-dayPrices are more steady: they fluctuate over months or even years
LiquidityVery liquid as stocks can be easily soldNot very liquid, can take at least a month to sell
DiversificationCan easily diversify stock portfolio by investing in different stocks or mutual fundsMore difficult to diversify since real estate requires a lot of money. Real estate investments typically tied up in just a few properties
Asset AccessibilityEasy access: can buy stocks on a small budgetMore difficult: must have at least 20 percent down payment and be able to secure financing

It’s worth noting that stocks are not a bad investment by any means. Despite focusing on real estate, I still keep about 20% of my assets in the stock market. I do believe it is important to have diversification.

I remember a conversation I had with an older gentleman. Although he was impressed with the real state empire I was building, he was concerned about my lack of diversification. He was worried that I would go down if real estate took a hit. It took several years, but I realized what he meant when 2008 came barreling down on me like a freight train.

I believe that a direct investment in real estate is not for everyone, but some combination of real estate and stocks can help create a balanced portfolio.

REIT As An Alternative Real Estate Investment

If you think real estate is a good investment, but do not want the hassle of owning actual property, you could invest in a REIT. A REIT is a Real Estate Investment Trust, which is another way to say real estate fund.

Much like an ETF or mutual fund in the stock market, a REIT combines the money from investors to buy real estate. You will get much of the benefit of owning real estate with none of the hassle. It won’t perform as well as owning the property yourself, but they are a great alternative and a fantastic way to diversify your investment portfolio.

How Important Is Diversification For Your Investing Portfolio?

As the saying goes, you should never put all of your eggs into one basket. Both real estate and the stock market have their share of pros and cons when it comes to risk and reward. As such, I believe it’s crucial that you diversify your portfolio to include both. Doing so can help reduce your risk and improve your odds of success.

For instance, if your stocks are doing poorly because of poor market conditions, you can rely on your real estate investments to keep your head above water – and vice versa. Not to mention that if one does poorly and the other does well, you can offset your capital gains with your losses within a single tax year, which means you can save on taxes and maximize your gains.

Invest In A Diverse Set Of Assets

The most successful investors have a balanced portfolio. They will likely buy both stocks and real estate, and maybe other investments like precious metal or private lending. It is smart to consider and compare different investment opportunities, like stocks or real estate, but sometimes it pays to own both.

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