Deciding how to invest your money can be daunting.
There are just so many options. You want to earn great returns while balancing your risk tolerance, timeline, and desired involvement. It’s hard to choose the best investments for your personal goals.
The stock market is where most people turn, but real estate is an alluring investment opportunity you might be curious about, too.
Of course, you’re not limited to one or the other. If I had to venture a guess, I’d say most people who invest in real estate also invest in the stock market.
But the reverse isn’t true: most people who invest in the stock market probably don’t invest in real estate (outside of owning their own home).
That’s because real estate carries unique features that can make it less accessible than stocks. That said, it comes with benefits, too.
So, which is a better fit for you? Stocks, real estate, or both? Let’s take a look at the pros and cons of each.
Investing in the Stock Market
When you buy a stock or share, you’re buying a small part of a business. Because you own a fraction of that company, you get a portion of their profits.
You can make money in two ways: 1) selling the stock for more than you paid, or 2) receiving dividends as a shareholder.
In addition to buying individual stocks, you can buy shares in exchange-traded funds (ETFs). ETFs can be a great way to own shares in a variety of stocks while avoiding high management fees. They’re often an attractive option for people who want exposure to the market but don’t have the skill or time to choose their own stocks.
Benefits of Investing in Stocks
Here are a few reasons you might want to invest in the stock market:
Attractive Historical Returns
Countless people have staked their fortunes on investing in stocks, and there’s a sound reason: historically, the market has yielded good returns.
This isn’t to say every year has been a winner for the stock market (2008, anyone?), or that all stocks always increase in value. But the S&P 500 Index’s average annual return since its inception in 1926, adjusted for inflation, is about 7%.
Historical returns are no guarantee, but they suggest that if you buy and hold an index fund mimicking the S&P 500, you should expect an average annual return close to 7% over the long haul.
Getting started with stock market investing is incredibly easy. All you need is a self-directed brokerage or robo advisor account. You don’t need a pile of money, either. You can buy some individual stocks or ETF shares for as low as a couple of dollars apiece.
Ease of Diversification
Diversification means minimizing risk by including a variety of asset classes in your portfolio.
Index funds make diversification easy, because you get exposure to all the stocks in the index. That could mean hundreds of different stocks. Most investors can’t afford to buy that many individual stocks but can easily afford to buy into an index fund.
When you invest in the stock market, you can be as active or as passive as you like.
Some people relish the thrill of trying to beat the market by timing their trades just right. Others want to buy and hold an index fund and only check their returns quarterly.
When it comes to passive income ideas, investing in the market can definitely fit the bill. All you have to do is buy shares in an index fund or of individual stocks and then sit back and wait. Dividend-paying stocks deliver a regular income stream that requires no effort from the investor beyond making that initial purchase.
While it isn’t always lucrative to trade stocks frequently, one benefit of the market is that you can buy and sell quickly and easily. This is a major advantage for people who might need to cash out their investments at the drop of a hat.
Drawbacks of Investing in the Stock Market
The stock market offers a good fit for many investors, but it’s not without drawbacks.
Although the market tends to yield positive returns over the long term, it can be quite volatile in the short term. The value of stocks can fluctuate widely from day to day or even month to month. For this reason, although stocks are technically liquid, they often work best for investors with a long-term strategy.
You know that volatility we just talked about? Not everyone does well with it. Some investors panic when their portfolio suddenly drops 15%. They live in a constant state of stress, obsessed with their returns. Worse yet, they sell low and end up losing a bunch of money.
Investing in Real Estate
Traditionally, when you invest in real estate, you buy land or property. You make money by selling that land or property for more than you paid or by renting out property to tenants for a monthly fee (or both).
Benefits of Investing in Real Estate
Buying a rental property appeals to a certain kind of investor. Here’s why you might consider it:
As with the stock market, nothing is guaranteed. History shows us, however, the value of real estate tends to increase over time. It’s very possible that the rental property you buy today will be worth more when you sell it in 20 years. This is one reason real estate is an appealing option for investors with long time horizons.
Investing in real estate helps protect investors from the negative impact of inflation. While inflation can be bad news for certain types of investments, it’s great news for real estate. Increased cost of living means higher rent, which means more money in a landlord’s pocket. It also means your property will command a higher price if you sell.
Depending on your setup, owning a rental property can be a source of passive income. It can also be a ton of work.
If you hire a property manager for sourcing tenants and dealing with the day-to-day management, the rental income you earn (less property management fees and expenses like property tax and maintenance) is passive.
You put in significant effort up front but continue to generate income for a long time after. If you pay off the mortgage and continue to rent out the property, most of that money goes in your pocket.
Drawbacks of Real Estate Investing
If real estate investing didn’t have some serious drawbacks, everyone would do it. Here are a few things to consider:
Being a landlord comes with its challenges. The biggest is tenants.
First, you have to find suitable tenants—not always an easy task. You hope you’ll find good people who pay their rent on time and don’t trash your property, but you won’t know for sure until it’s too late.
Then, even if you find great tenants, you’re on call 24-7. Any issues that come up with the house are your responsibility, and you better believe they’ll call you and expect immediate action.
You can always hire a property manager to find tenants, collect rent, and respond to maintenance issues, but that will eat into your profits.
Another option is to invest in real estate through a real estate syndication (group investment). As a passive investor in a real estate syndication, you pool your resources together with other passive investors to invest in a larger property, like an apartment complex. Best of all, you get all the benefits of investing in a rental property (monthly passive income, tax benefits, and more) without having to deal with the hassles of being a landlord.
Lack of Liquidity
Unlike stocks, it’s generally difficult to sell real estate quickly, making it an illiquid investment.
Even in a hot seller’s market, it takes time to list a property, have a real estate agent show it, and close a deal. In a slower market, you might not see movement for months or years. Therefore, real estate investing isn’t a good choice for people who may need to cash out quickly.
It costs little to get started with stock market investing, making it extremely accessible to the average investor. This isn’t the case with real estate.
When you buy a rental property, you must arrange a mortgage and pay a large down payment – often as much as 25% of the purchase price for investment properties. This is the single biggest factor preventing otherwise interested investors from getting into the real estate market.
Bottom Line: Should You Invest in Stocks or Real Estate?
All in all, the stock market is more accessible than real estate investing, although that is shifting with the introduction of real estate crowdfunding platforms.
Both options work best for investors who are interested in long-term wealth building. The stock market is more flexible because of its liquidity. Real estate can give you more control and yield higher returns and better tax advantages.
For investors in it for the long-haul who can fund a down payment and don’t mind dealing with tenants (or hiring a property manager), rental property investing is an excellent opportunity.
If you want to invest in real estate without the hassles of being a landlord, you might consider investing in real estate syndications.
Have you tried investing in the stock market, real estate, or both? Let us know in the comments!
Sandra Parsons is a freelance writer and staff writer for Club Thrifty, a website dedicated to helping people dream big, spend less, and travel more.