Think about your long-term goals before you choose an investment. Real estate gives investors more control over what they buy, what they do with their investment, and how much monthly income they can get. Mutual funds have benefits, but investors have to put their trust in a mutual fund manager.
So you want to invest your money...but where?
Depending on the investors and professionals that you talk to, you’ll probably hear strong opinions on where to put your money and what type of returns you should expect. The debate over real estate and stocks is as old as time, but in this post we’ll take a look at a slightly different debate. If you have narrowed down your choices to real estate or mutual funds, you might find yourself having to choose very different paths.
Every investor has different goals and different abilities to manage their portfolio. Consider how much time and money you want to invest before you choose one specific path. Hopefully, within no time, you will find yourself with the means to invest in real estate, mutual funds, and other opportunities with ease!
Real Estate - Pros and Cons
Investors have many options if they want to invest in real estate. Some investors prefer to buy a vacation house and rent it out sporadically through the year. Others buy a second home and find long-term renters who occupy the property for 12 months at a time. And who could forget the "fixer upper" option of buying rundown property, renovating it, and selling it for a profit?
There are pros and cons to every real estate investment strategy, but let’s not get in too deep yet. Let’s look at the general pros of cons of investing in real estate.
(Which is better...flipping houses or owning rental property? We discuss the answer in our blog post.)
Pro: Tangibility and Usability
If you have already purchased real estate, you have invested in real estate. Primary residences that are well-maintained and exist in a growing market can usually be sold for profit down the line.
Real estate investments are just that - real. You can physically touch a vacation house with your hands. (You can also use it when you go on vacation.) The tangibility of real estate investments doesn’t just give you a potential place to sleep. Investors can sleep easy at night knowing that their investment will always be worth something.
Mutual funds are made up of securities that are "tangible" only in the form of a certificate. It is very possible that your stocks or bonds may be worth nothing in the future.
Con: Maintenance
This physical investment can’t just sit idle. In order to make passive income with real estate, you will have to maintain the property. If you have renters, you will have to prepare the property and possibly furnish it. If you prefer short-term rentals, you will also have to take time to find renters. Listing your property on AirBNB, Craigslist, or other renting websites takes time.
Once renters arrive, you may be in charge of paying utilities, unclogging sinks, deep cleaning carpets, or making more intense repairs. All of these repairs come with costs, especially if you want to hire someone to do all the dirty work for you.
Pro: Value Appreciation As You Make Passive Income
Once you get renters, you can start making income that will cover the monthly costs of your mortgage, HOA fees, and even utilities. Even if you just break even every month, you can still count on the fact that your investment is growing.
Real estate appreciates over time. In a hot market like Austin, Texas, home values can increase 10% in just one year. If you spend even a few weeks "flipping" a house in a hot market, you can make serious income.
Real estate investors who hold onto their investments for a longer period of time can make huge gains, even in rocky markets. Real estate is a more safe investment than individual stocks; the value of real estate will generally increase over time. Even with basic repairs or maintenance, you can get satisfying returns on your investment in a few years.
Con: Initial Costs
In most cases, the first step of investing in real estate is to buy real estate. This can be a turn-off for many new investors. In order to buy property, you have to get approved for a mortgage and cough up a few thousand dollars for the down payment. This doesn’t include the initial costs of preparing the property for renters.
We say that this is generally a con, but there is a silver lining. It is easier (and generally smarter) to invest once you have a few thousand dollars for a down payment, but real estate investors who have no money to start still have options.
Pro: Tax Benefits of Real Estate
When you compare real estate and mutual funds, you have to consider taxes. Investors will have to pay capital gains tax whether they invest in real estate or mutual funds. But when you invest in real estate, you have the ability to deduct more expenses or find more tax-free opportunities. Tax-exempt mutual funds exist but severely limit your options.
Property owners who live in the houses that they flip don’t have to pay taxes in their properties. Flippers who exchange one property for another can avoid taxes through a 1031 exchange. Investors don’t have to pay taxes as the value of their home appreciates and have the ability to use depreciation as a tax deduction. There are many options for real estate investors who want to avoid high taxes.
Talk to a financial advisor about the opportunities to avoid taxes on your investment, whether you want to invest in real estate or mutual funds.
Mutual Funds - Pros and Cons
Mutual funds are a group of securities (stocks, bonds, REITs, etc.) bundled together in a single investment. Investors hand their funds over to mutual fund managers, who choose which securities to invest in. As these investments see returns, the managers can continue to add more securities to the mutual fund’s portfolio.
Unlike physical property, investors can buy into a mutual fund with just $1,000. Investors should take a close look at different mutual funds and fees associated with purchasing or exchanging their shares.
Before you commit to mutual funds, consider the following pros and cons of mutual funds.
Pro: Diversification
Mutual funds allow you to own shares in multiple businesses instead of putting all of your eggs into one vacation-home-sized basket. If investors want to stick to investing in the real estate industry, they can invest in real estate mutual funds. Or, investors can choose to invest in mutual funds that buy shares in government bonds or a specific type of stock.
Con: Fewer Chances for Passive Income
Because mutual fund managers can choose to invest in more properties, investors may not see those returns until they sell their share. This is okay if you are investing in mutual funds for long-term growth, but frustrating when your landlord friends are getting hefty rent checks every month.
If you want to see the returns of your investment throughout the year, consider investing in a real estate investment trust (REIT.) REITs have a similar structure to mutual funds, but investors collect returns periodically.
Pro: Growth With More Flexibility
Once things feel pretty solid and you’re ready to sell, you don’t have to go through the process of hiring a real estate agent and staging a property. All you have to do is make the sale and wait for the transaction to process. (Unlike selling stocks or ETFs, it may take one to two days for the sale to go through. Mutual funds are only sold once a day after the market closes.)
Before you sell, keep in mind that you might have to pay fees.
Con: Volatility of the Stock Market
As we mentioned earlier, the real estate market is generally steady. The stock market, however, isn’t. Just think back to the last days of 2018. As the stock market dramatically rises and falls in the span of a day, you may feel that you are on a roller coaster with your investment. This roller coaster can be especially frustrating when you don’t have control over the securities that you invest in. Investors put a lot of trust in mutual fund managers.
Our Conclusion: Real Estate Offers More Control
If you already have a plan for your overall investment portfolio, you probably can already tell which type of investment fits in with your goals. But if you are still weighing both options, consider how much control you want over your investment.
There is one central theme throughout the pros and cons of real estate: control. Real estate investors have control over:
- What properties they buy and how they maintain them
- How much they rent out individual units for
- When to sell the property or occupy it
Instead of handing their fate over to mutual fund managers, real estate investors have the final say in where they put their money. Investors also have more control over the value of their property; while stocks can be unpredictable and change drastically in a moment, real estate is generally steady.
So the real estate vs. mutual funds debate has been settled. Ready to start investing in real estate, but not sure where to start? Read our guide to real estate investing for beginners.
