There will always be a hot talk in the personal finance community about investing in real estate versus stocks. I do bothSo today I’m going to share details of two of my long-term retirement assets.
Asset # 1 is a rollover IRA account. The current account balance is approximately USD 109,000. Asset # 2 is a buy and hold rental I’ve owned for five years. Coincidentally, it’s worth around $ 109,000 too!
Although Both investments are worth almost as much as they are todayThey belong to different asset classes, have different risks and one is a passive investment while the other is constantly managed.
In time, I think it’ll be fun Follow your individual growth side by side and see which ones we can call a “better investment” in the long run.
Ultimately, I don’t care which one beats the other as I already own both and will keep them regardless of the long term. But I hope it will be an interesting journey for you that you can follow and help answer some questions … and maybe help me prove a general hypothesis. More on this below!
(Also note that I always use the words then “I, my, me, or Mine “ About these investments, I really mean “our.” All of the assets I talk about belong to my wife!)
Asset # 1: index funds in a rollover IRA
I have an IRA account with Fidelity. The money in this account is the result of two previous 401k programs by the employer. When I left these old employers, the 401,000 funds were transferred to this regular IRA account. I haven’t touched or contributed to this account since leaving my last employer two years ago. Since I don’t have a current 401k plan, I won’t be contributing to this rollover account for a long time – the initial investment amounts are to be estimated on their own for now.
The current balance (as of July 1st, 2020) is USD 109,602.
This is fully invested in a stock index fund that gives me a diversified portfolio without having to create one. The remaining amount corresponds to around 1,250 FSKAX shares. (For you Vanguard aficionados, this is Fidelity’s equivalent to VTSAX.) All dividends are set up to automatically reinvest in the fund, and everything will increase over time.
I am assuming that this account will grow an average of 9% per year if left unaffected. Only time will tell what the real returns will be – no one can predict the future of stock investing! I’m assuming this 9% growth rate is based on historical returns and does not take inflation into account.
What I love about investing in index funds is that it doesn’t require any effort. It’s a set-and-forget stock investment that doesn’t require physical or mental energy to maintain. I wish I had invested more in the stock market sooner, but I only moved to the US 12 years ago and learned the 401k game too late!
Asset # 2: A buy and hold rental property in Texas
I bought my first rental property outside of the state in Texas in mid-2015. It took about 10 months to find and shut this place down, and it’s been a steady little fortune breeder ever since. This property has positive cash flow, with incoming rents exceeding outgoing costs.
The property is currently valued at approximately $ 220,000. Between the last fiscal value ($ 220,000), comparable properties in the area (values between $ 180,000 and $ 250,000) and the “feelings” of my local real estate agent, a valuation of $ 220,000 seems like a fair market price.
I have an outstanding mortgage of $ 123,708 on this property and an emergency checking account with $ 13,334 in cash. All rental income is paid into this checking account and all costs are deducted from it.
All in all, this asset is currently worth it $ 109,626.
Real estate growth potential
The growth for this rental is a little harder to project. It’s also extremely boring to research and write about (at least for me). So for now, I’ll simplify it by dividing growth into three categories.
This rent makes money in three ways:
1. Loan repayment. Since the tenants pay my mortgage, a small portion of the loan balance is repaid every year. This year, the loan balance will decrease by around $ 2,820 in 2020.
2. Positive cash flow. This property brings in rental income of $ 1,975 each month but has expenses of approximately $ 1,750. So that’s about $ 225 positive monthly cash flow, or $ 2,700 a year. Sometimes it’s more, sometimes less, but that’s the average.
3. Appreciation. Over time, property prices in the area should go up and this house should keep getting worth more. I expect it to increase by around 2% per year. Of all the assumptions I make, this is probably the greatest. There are a million reasons house prices get more expensive – faster in one property market, slower in another – and my way of calculating this has been very conservative. My guess (and minimal hope) is that this property will appreciate at the same rate as general inflation.
Overall, I estimate this property will increase $ 2,820 (loan repayment) + $ 2,700 (cash flow) + 2% of property value this year. That’s roughly $ 9,920 this year.
Since my current equity is $ 109,626, the growth rate is around 9% (return divided by equity). That% yield will float up and down a bit from year to year, but at this point it is my best estimate of future growth.
Tracking Real Estate Versus Stocks Over Time, Comparisons, and Questions I Think About …
So we have two completely different assets, both of which are currently valued at around $ 109,600 and are both hopefully growing at around 9% per year. Let’s forget about tax and capital gains for a moment … Here are some things I wonder:
- If left untouched, will they both be worth the same amount in 10 years? What about 20 or 30 years old?
Maybe, but probably not. Since the index funds include zero management, the return will be as it turns out. There is not much I can do to sway the price of the entire stock market.
I can personally do a lot for the rental property to influence the return. I can raise rents, refinance loans, negotiate expenses, make profitable upgrades to the property, etc. All of these things could give me a higher return.
On the other hand, if I neglect or poorly manage the rental property, I could drive my profits into the ground. Many new property investors believe that rental properties are passive income investments. If left unattended, profits are accidentally lost over time. F.Future returns depend on the investor’s ongoing actions.
- Which one will surpass the other?
Only time can tell. I will definitely try my best to make sure the rental property is properly managed. But I really have no idea what’s going to grow faster. (And capital gains tax will have a big impact if I decide to sell any of these assets.)
- If real estate investment outperforms the IRA, is the excessive growth worth the effort / time / risk involved in managing the investment property?
This question keeps me up at night.
Let’s say I break my balls and manage the rental property like a rock star for the next 10 years. After years of being diligent and efficient, I could see an annual growth rate of 10% instead of my projected 9%. Over a 10 year period, the difference is between 9% and 10% an additional $ 25,000.
Is that additional $ 25,000 worth the risk and monthly expense of managing a rental property for 10 years? What if the difference was only $ 10,000? Honestly, I don’t think the extra money is worth it. Rentals are hard work. And if I ever sell the place it could cost me $ 25,000 in commissions and transaction costs just to sell it!
- If I can achieve long-term “similar” returns with index funds compared to rental properties, why invest in real estate at all?
In my 20s, I was hungry for money and passionate about real estate. If there was a choice between an easy and a hard way to build wealth, I’d take the hard way. (I have an unconscious philosophy that choosing the more difficult paths in life is more rewarding, even when you fail.)
But now as I mature and learn about risk-adjusted returns, I feel like the easier route to wealth might be a better choice. Why make it harder than it has to be?
While I’m still into real estate investing, I hesitate to openly advise others to go out for better or worse and buy rentals without fully understanding the long-term commitment and continued hard work of owning an income property. This is an investment strategy that I do not support!
Real estate versus stocks … let’s see how things grow over time!
I hope the public pursuit of these two assets gives you some insight into the different ways index funds and rental properties can help you build wealth over time. Plus, I’ll do my best to talk about the * efforts * involved in managing residential property as an investment, while sharing stories.
We’ve had a crazy 2020 so far, which is causing the stock market to do weird things. The real estate market is also affected and it will be interesting to see what happens over the next few years.
More on this. If you have any questions for the time being, throw them in the comments below and I’ll try my best to answer them!
* Picture of Nattanan Kanchanaprat