It’s a common question, which is a better investment, stocks or real estate? You might have faced this question yourself. For example, if you’ve decided whether to put money towards a down payment or your retirement, you may have explicitly or implicitly thought about this. Or if you’ve wondered whether you should buy a rental property or invest, you’ve thought about this. There is a lot of misinformation about which investments are better than others. And there are many people with super strong opinions that are just that, opinions.
In this piece, I’ll go over types of investments in stocks and real estate, which investments are better for earning passive income and investment income, and important things to consider when comparing real estate vs. stocks. I focus on stocks (also called equities) and real estate because these are two of the most common types of asset classes. They’re also the ones that tend to come with the best returns over time.
Other asset classes include things like fixed income (cash), bonds, and commodities. Those tend to return less over time and be less reliable, so I don’t focus on them here. However, if you’re interested in learning more about them, you can check out my beginner’s guide to investing. I hope you can use this as a resource to evaluate which investment options work best for you and your financial goals.
Types of Stock Investments
If you’re pretty new to investing, then you may think about investing primarily in terms of investing in individual companies. However, there are tons of different ways to invest that you can tailor to your risk tolerance and goals.
Index Fund Investments
For those of us with a lower risk tolerance but who want steady returns, broad market index funds or exchange-traded funds (ETFs) are great options. Index funds and ETFs are bundles of investments that fit a particular category (like large companies or small companies) and tend to be well-diversified. For example, one of the most popular (and safest) index fund options are ETFs and index funds based on the S&P500. These investments are made up of the largest 500 companies on the U.S. stock exchange.
By buying these index funds/ETFs, you get a piece of all of those companies. These investments also have low fees because they are passively managed. In other words, they update themselves as companies enter and leave the stock exchange.
If you have a higher risk tolerance, you might go for an index fund or ETF based on small- or medium-sized companies, emerging markets, or a particular industry like tech. These funds are also made up of a large number of companies, making them pretty well diversified. However, they come with higher risk and higher potential reward than investments based on large companies.
Investing in Individual Stocks
And if you have a very high risk tolerance, you might invest in individual stocks or companies. Generally financial advisors recommend that you only try this strategy with play money that you’re okay with losing. The success of individual companies is influenced by everything from management quality to industry dynamics to consumer sentiment and it’s impossible to predict how each of these things will play out. However, if you have a company or industry you’re very interested in and have knowledge about, you might try this strategy.
Income vs. Value vs. Growth Stocks
Within each of these types you can also get stocks classified as income, value, or growth stocks. These each come with different levels of risk and reward. For example, income stocks tend to have the lowest risk and are characterized by their payment of monthly dividends. In contrast, growth stocks have the highest risk level. Stockfit has an excellent overview of each of these types of investments, as well as an assessment of how they have performed over time.
Finally, there are mutual funds. Like index funds, mutual funds are pools of investments that tend to offer diversification and a focus on a particular industry, company size or goal. However, mutual funds generally come with higher fees and no better outcomes than index funds or ETFs. Financial experts rarely recommend them anymore as a result.
Pros of Stock Investments
So what are the advantages of investing in the stock market? I focus on 5 big ones here.
1. Earning Investment Income is Relatively Passive / Hands-Off
Investing in stocks is one of the best ways of earning truly passive income. Aside from initially opening a brokerage account and choosing your investments, you can set up automatic investments and sit back and let your money grow over time. They are therefore much more passive than real estate which generally involves more knowledge and hands-on effort, as I’ll discuss below.
2. Equity Investing Can Be Very Simple
Similarly, while investing might seem complicated, the best investing strategy is often the simplest. For many people, investing in index funds or ETFs will meet most of their needs. You can do this through a retirement account or opening a personal brokerage account. Thus, the good thing about stock investing is that it works very well for first-time investors searching for financial independence or just more financial security.
3. You Don’t Need Much Money to Get Started Investing
Additionally, you don’t need much money to get started. Nowadays, many financial companies allow you to purchase fractional shares. Fractional shares are partial shares of investments. This makes it so that you can start investing in everything from Tesla to a broad market index fund with very little money. In contrast, real estate investments often involve large upfront costs and maintenance costs over time.
4. Equity Investments Are Relatively Liquid
Stock investments are also relatively liquid assets. In other words, if you are investing in a brokerage account (aside from some kinds of accounts with withdrawal limitations like retirement accounts), you can pull your money in and out of the stock market if you need it. Of course, the most successful investors are long-term investors that leave their money in the stock market. However, this liquidity is an advantage over real estate which tends to involve fewer half measures. You can’t exactly sell off 10% of a house if you need money at the last minute.
5. Investment Returns Are Relatively Reliable in the Long-Run
Finally, stocks market investments have historically yielded reliably high returns over time. For example, over the past 30 years, the S&P500 has returned an average of 10% per year, even accounting for market downturns. As such, stocks are a great investment option for those looking for long-term returns with relatively little effort.
Cons of Stock Investments
While stock market investments come with a lot of pros, there are some cons of stocks. First, you may have to pay capital gains tax on returns. If you only invest in tax sheltered accounts like retirement accounts, this will not be relevant. However, if you have a traditional brokerage account, you will pay capital gains on any stock market returns in a year. Luckily, these taxes are generally lower than income taxes if you hold an asset for more than a year. Nevertheless, it’s an important downside to keep in mind.
Additionally, stock prices are subject to market volatility. For example, over the course of the stock market’s history, it has generally dropped by 10% every 1.6 years and 20% every 4 years. This isn’t a big problem for long-term investors. However, it’s important to keep in mind if you have near-term goals. Indeed, you should only invest in the stock market for goals that are 5 or more years out.
Types of Real Estate Investments
House Hacking and Rental Properties
There are a wide variety of types of real estate investing. For example, you can house hack. House hacking involves using your primary residence to earn money. You can do this by renting out a room, section of your home, or even garage or storage space for rental income. You can also rent out rooms or sections of your house through short-term vacation rental sites like Airbnb or VRBO.
For those with considerable knowledge of the housing market and home restoration, you can even purchase a property, restore it, and flip it for a higher purchase price. House hacking can be a good option for real estate investors who cannot purchase rental properties, but who want to earn a steady stream of side income. For more details on house hacking, you can see my house hacking guide.
Individuals with more resources can invest in a rental property (or properties) that are separate from your primary residence. Some people buy single-family homes, commercial real estate like office buildings, or rental properties like an apartment building or duplex.
Real Estate Investment Trusts (REITs)
Finally, you can invest in real estate properties without purchasing any kind of physical asset. You can do this through real estate investment trusts or REITs. A REIT is a company that owns, operates, or finances income-producing real estate assets. These assets could include residential real estate like single- or multi-family homes, commercial real estate, or even factories. By investing in REITs, individuals can invest in these income-producing properties without having to purchase, manage, or finance the properties themselves.
Plus, REITs have to pay out 90% of their income in dividends, meaning that they offer the possibility for both dividend income and stock appreciation. REITs can therefore be a good way of building your real estate portfolio without requiring a lot of money and time. Inesting in REITs is similar to investing in stock equities. If you want more info, you can check out my post on REITs.
Pros of Real Estate Investments
1. Good Annual Returns and Lower Average Volatility
As mentioned above, the stock market has, on average, returned 10% per year. Real estate has had virtually the same average returns for the past 25 years.
Both the stock market and real estate market are subject to volatility. However, the real estate market tends to be more stable. This is, in part, because people need a place to live. And the past 15 years have seen a big tightening in the housing market. In other words, there is far more demand for houses than supply. Despite recent instability in real estate prices, many experts believe prices will still go up in the long run because people need a place to live.
The increase in housing prices also means that many people will likely have to continue to rent. This suggests that rental real estate will also continue to earn money. There is a lot of uncertainty about all of this, and little sense of when the right time is to buy real estate. Nevertheless, real estate returns have generally been reasonably high and are expected to remain so in the long term.
2. Tax Benefits of Real Estate Investments
Additionally, there are some tax benefits to owning physical property. You can earn tax deductions from your mortgage interest, mortgage insurance, and real estate taxes. These deductions can lower your overall tax bill. Keep in mind tax advantages are kind of like buying an expensive item on sale for 10% off. You may have saved money on the thing you bought, but you still spent a lot of money on that thing.
3. Earn Money on an Asset You Already Have
If you already own a home, then using tools like house hacking can help you make money you wouldn’t otherwise have. Of course, this benefit doesn’t hold if you need to purchase real estate. However, it is an advantage if you have an asset just waiting to be tapped.
Cons of Real Estate Investments
1. Requires Considerable Knowledge
While real estate comes with a number of pros, this type of investment also comes with a large number of cons. For one, buying an investment property involves considerable know-how. You need to understand property value and the impact of interest rates on your investment, fluctuations in the real estate market, and, in some cases, have property management skills.
Indeed, if you plan to be a landlord or rent out property, you may want to work with a property management company (which will eat into your returns) or take courses in how to manage properties. All in all, you need to do a lot of due diligence before diving into this investment strategy.
2. Low Investment Liquidity
Additionally, cash flow and liquidity are much lower with real estate than with stocks. You can tie up a lot of money in real estate investment properties and have few opportunities for getting that money out quickly. If you pursue this strategy, you’ll want to make sure you have enough assets to avoid selling anything at a substantial loss.
3. High Phantom Costs
Moreover, there are a variety of phantom (invisible) costs that come with real estate. These include things like maintenance costs, property taxes, and HOA fees. If you hire a property manager, that is another fee. Likewise, if you plan to flip the property, you’ll need to account for substantial selling costs, including real estate agent fees. These phantom costs quickly eat into returns you earn from selling or renting property.
Finally, few people truly understand how much mortgage interest they’ll pay on a property. For example, if buy a home and are able to put down a 20% down payment, about 80% of your mortgage payments for the first 10 years will go towards interest. Consequently, it’s a long time before you build substantial equity as a property owner.
4. Generally Limited Diversification
Real estate investing generally involved limited diversification. For example, if you buy a rental property, your investment will be affected by the broader housing market, your local area, the quality of the unit, and so much more. Diversifying your investments is helpful because it spreads risk out. If you own stock in Tesla and Pfizer for example, those are two very different companies with different risks and benefits. It’s much harder to diversify real estate investments unless you invest in REITs or can buy lots of properties with different sizes, uses, and locations.
Real Estate vs Stocks
So which is the better investment? To sum up, real estate and stocks have tended to earn comparable returns over time when it comes to buying and selling investments. However, stocks generally require a small initial investment, offer easy ways of building a diversified portfolio, are a simpler investment strategy with less know-how involved, and involve fewer phantom costs. While they come with higher volatility, that is of limited concern if you are able to keep your money in the stock market for 5 or more years.
Does that mean you should definitely go with stocks over real estate? Not necessarily. Real estate can still offer a compelling way of diversifying your investment portfolio in addition to stocks. Those who can spend a lot of time learning about the real estate market have even earned better returns than what is highlighted here.
Plus, rental properties and house hacking can earn you consistent income and improve your net worth. And REITs offer the opportunity to create a diversified portfolio without spending a lot of time learning about real estate.
The bottom line is that if you’re looking for a simple investment strategy that will earn you good returns in the long run, sticking with stocks may be best. However, if you are able to spend some time learning about real estate and are in a financial situation where you can handle the larger costs of real estate, adding real estate to your investments can be a great way of creating another income stream.
Other Important Considerations of Real Estate vs. Stocks
The other thing to keep in mind when weighing stocks vs. real estate is your own values and goals. For example, I want to buy a home one day and am saving aggressively for that goal. While I know I could likely earn higher returns by investing all that money I’m saving in the stock market (I live in Seattle where housing costs are sky high), I want to own a home and so am choosing to pursue that goal. I also invest in stocks for my retirement. Just not as much as I could if I diverted all my savings to investments. So it’s worth thinking about the non-monetary returns you might earn from different kinds of investments.
Additionally, no one has a crystal ball that can see the future. Or if you do, please let me know! Just because investments have performed a certain way in the past, doesn’t mean they will in the future. All of this information comes from research and advice I have found from financial experts and publications. But we all know that experts’ predictions haven’t always worked out.
With any investment, be sure you understand the risks of the strategies and the potential returns to the best of your abilities. There is no safe, short term investment option that will earn you really high returns. Beware any promises of easy money. The better option is to do your due diligence, exercise patience, and remember that the best returns happen over a long time of consistent investing.
Final Thoughts
Remember that I am not a financial advisor. This information is solely for informational and entertainment purposes. Before making any financial decisions, it’s a good idea to speak with a professional.
Did you enjoy this post? If so, please consider liking, subscribing, or sharing with others. It’s always a huge help! Interested in related posts? Check out my posts on things to know as a first time home buyer (+ free home buying budget calculator!), house hacking, and investing for retirement.
Thanks for providing a detail overview of real estate investment and stocks
Thank you for reading!
Thank you for this amazing resource and guide. You are so right! There is so much misinformation about which investments are better than others – it’s hard to keep track of it all.
I’m so glad it was helpful, thank you for reading!
I’ve always been interested in investing. Thanks for the great information and helping to understand it better.