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Although most investors can benefit from a diversified portfolio, investors often tend to favor either equities or real estate. Although both types of investments can offer capital appreciation, income, or both, they are quite different in terms of general characteristics.
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If you’re resigned to choosing only one option, either stocks or real estate, you need to understand the risks and rewards that each type of investment offers. Here’s an overview of the pros and cons of stocks and real estate so you can determine which best suits your investment goals and risk tolerance.
Return
It’s difficult to compare long-term returns between real estate and the stock market because each asset class has a wide variety of potential risks and rewards. However, the simplest comparison with the most data points is buying a home versus owning the S&P 500 stock index. In this regard, there is no real competition. Over the long term, the S&P 500 has returned about 10% per year to investors on average compared to only 3% or 4% for real estate.
Volatility
Although stock market returns typically far exceed long-term real estate investments, investors must pay a price in the form of volatility. While house prices can drop by double digits in a terrible year, the stock market can drop 10% in a matter of days. During a bear market – which occurs about every 3.6 years on average – the stock market falls by an average of 36%. In some cases, bear markets have seen stocks fall by 50% or more. This type of volatility simply does not occur in real estate, except perhaps in the most speculative segments of the market.
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Liquidity
A huge advantage the stock market has over real estate is its liquidity. You can literally sell any stock you want at any time during market opening, and often after hours or even before the market opens. With most stocks, you will also benefit from an extremely active and liquid market where you can see fair market prices for your stock at all times.
If you are selling a house, on the other hand, you may have to wait months or even years to unload your property, and you may never know what the “true” or “fair” value of your property is. , because you are subject to everything that a single investor is willing to pay you.
Investment size
Investing in real estate generally requires more money than buying stocks. While land or developed property can cost tens of thousands, hundreds of thousands, or even millions of dollars, you can buy fractional shares at some brokerages for just a few dollars. Some listed investment pools and real estate investment trusts may offer lower initial investment costs, but owning a property generally requires a much larger investment than buying a stock.
Leveraged returns
Real estate can offer the advantage of leveraged returns. While it’s true that investors can borrow against the value of their accounts to buy additional shares – known as margin trading – you can usually only borrow up to 50% of the value of your wallet. But the traditional down payment on a home is only 20% of the purchase price, and many buyers only put down 10% or less. This maximizes returns and offers owners the opportunity to earn a high percentage return on their initial investment. For example, if you invest $20,000 on a $100,000 house, you will double your $20,000 investment if your house simply increases 20% to a $120,000 appraisal.
Taxation
Real estate and shares are fixed assets, which means they are taxed the same way. Profits generated in one year or less are considered ordinary income, while those realized after more than one year are long-term capital gains, subject to reduced tax rates.
However, real estate offers a wide range of tax deductions that are not available to stock investors. For example, if you own your own home, you can deduct your mortgage interest, home equity interest, discount points, necessary home improvements, mortgage insurance, and property taxes (up to $5,000 for single registrants or $10,000 for joint registrants).
Benefits of a diversified portfolio
Stocks and real estate are valuable investment assets that offer different characteristics. For this reason, they can greatly complement each other as part of a diversified portfolio. In addition to providing a place to live, residential real estate can offer a variety of tax benefits and the potential for long-term capital appreciation. Rental real estate can provide passive income in the form of monthly rentals that typically increase each year, in addition to capital appreciation. Stocks are generally held for their growth potential, but many stocks also pay dividends which also increase steadily, thus also providing an opportunity for income. The best course of action may be to own both asset classes in a diversified investment portfolio that you design together with a financial advisor.
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