mutual funds

(This article is part two in a two-part series on stocks versus real estate)

Last time, I discussed the idea of the “hero stock” and why the idea of “just picking that one special stock” is absurd and dangerous to your money.

In an answer to this gamble, many financial advisers recommend a diversified (spread out) portfolio, using mutual funds to spread out risk over dozens or hundreds of large companies. This definitely spreads out the risk of losing all one’s money on a company that goes out of business.  The stock market on average over the past 40 years has provided an average return of around 10% per year. Stock salesmen love to point to this number and tell you that this return is better than anything you could get in real estate. Just give them all your money, plus their commissions, and they will provide for your future.

The problem is – with stocks and mutual funds, you are giving up the most important part of your ability to make money – your brain. You are completely dependent upon forces out of your control to make money. Yes, the stock market has traditionally provided a generally stable return, but this return is miniscule to what you could earn in real estate.  Are mutual funds better than nothing? Yes!  Anything is better than burying your money in the ground (or a checking account). An average return of 10% is better than losing money to inflation. However, average returns are for average investors.

By reading articles like this one – it is clear you are not a typical “bury in the ground” or average investor. You want more.  Real estate investing will give you more. Why? One word: leverage. Leverage is the ability to use borrowed money make you money. When you buy a stock, $20,000 lets you buy $20,000 worth of stock. With real estate, however, $20,000 will let you purchase $100,000 or more worth of property (or $500,000 if it is your personal home).

Lets look at an example.

You have $20,000 this year to invest. You want to decide between buying diversified stocks or real estate. Let’s look at both:

1. $20,000 invested for 10 years and receiving an annual interest rate of 10% could be worth $54,140.86 – a gain of about $34,000. Not to bad. This equates to an average annual gain of almost 17%.
2. You purchase a newer three-bedroom, two bathroom home in a family neighborhood for $100,000.  You put a down payment of $20,000 (the sellers pay closing costs). Total mortgage payment (on the resulting $80,000 at a 5% bank loan) is $430 per month. The home rents for $1200 per month.  After paying taxes, insurance, a maintenance guy to fix stuff when it breaks, and a other incidentals, you cashflow about $450 per month or $5400 per year. Putting this money back into the loan (not that you would have to, but to compare apples to apples from the stock scenario above), after ten years you will owe nothing on the loan.  Zip. Zero. Additionally, property in the US has appreciated at an average of 3% per year. So, you now own a property that is worth $135,000. Even taking out your initial investment and the cost it would take to sell, you have over $100,000 in equity, equating to a 50% return on investment – three times higher than that of the mutual funds. This 100,000 can now be used to invest in something bigger, better, and with more value.

At the risk of sounding too biased, there are drawbacks to real estate investing.  For one, the money is not liquid. This means that if you suddenly wanted to pull out all your money, it would take time.  Stocks are much easier to get in and out with.  Additionally, stocks do not require any extra leg work. You don’t need to drive by the stock, get phone calls from the stock, or evict a stock.  However, personally I could not invest in something that I couldn’t materially participate in. Perhaps its a lack of trust in others, but I want to have complete control over the destiny of my money. When I make or lose money, I want to make it or lose it by something I did or didn’t do.

This scenario is not a once in a lifetime deal or even a great deal. It is a very conservative look at investing. I believe in maximizing return by purchasing properties well below their value, adding tens of thousands of dollars in equity before even closing on the deal. In the house scenario above, I would have paid $60,000 for it instead, adding hundreds to monthly cashflow and tens of thousands in immediate equity. That is true real estate hacking.

P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.