With many financial wizards spreading prophecies of a coming recession, consumers are becoming increasingly hesitant about investing in either real estate or the stock market. Even if you decide one investment over another, there's so much variance across markets, there's no guarantee you made the best choice. You could buy a rental property in Miami, but then have rent prices skyrocket across the state in Tampa.
All in all, the tried-and-true wisdom still stands: having a diversified portfolio split between stocks, bonds, real estate, and other financial options tends to be the safest way to invest. That way, if any market crashes, there's always a few more to even it out and help you weather the storm.
If you're still unsure how to divide up your portfolio, here are some tips to help you figure out which investment route is right for you.
Investing in Stocks
When you invest in stocks, you're buying a piece of a company. As that company grows and its profits increase, so does the value of your stock. Stock investors have lots of options available to them: they can invest in blue-chip stocks, dividend stocks, penny stocks, and index funds, each bringing their own individual risk-reward profiles to the table.
Let's take a look at some of the pros and cons of investing in stocks.
- Reliable returns: In the long term, the stock market almost always goes up. Sure, there are corrections, bear markets, and recessions, but they're usually relatively minor downturns in an overwhelmingly upward march. If you want reliable returns, there are few more reliable investments than the S&P 500, which returns 8% on average each year.
- Set it and forget it: Unless you're a day trader, which is extremely risky, investing in the stock market doesn't require a lot of active effort on your part. Putting money into an index fund or a few blue-chip stocks and balancing your portfolio a few times each year is the best investment strategy for most people. The more active trading you engage in, the more risk you take on, and the majority of investors don't end up beating the S&P 500's returns anyway.
- You can lose it all: While blue-chip stocks are pretty safe, it's always possible for a company to experience serious financial troubles and its stock to plummet. This is why it's so important to have a diversified portfolio and not go all-in on one company.
Investing in Real Estate
For many, real estate is the gold standard of all investments. Like stocks, real estate provides investors with many diverse opportunities and strategies such as buying and holding, house flipping, and rental properties.
Here are some of the advantages and disadvantages of putting your money into real estate.
- You own physical property: When you buy real estate, you're buying a real, tangible item. No matter what happens to the market, a property will always be worth at least the price of the materials it's made of. Even if the market completely tanks, you should be able to get some of your investment back.
- Reliable returns: Just like the stock market, investing in real estate has a long track record of great returns. While crashes do happen, the market always recovers.
- You have more control: While you can't change the trajectory of the market as a whole, you can take actions that affect the value of your investment. Performing renovations and repairs will make a property's value increase, and you can actively seek renters if you want to earn income from your property.
- Requires a more active approach: Investing in real estate isn't as simple as opening a brokerage account and putting some money into an index fund. When you invest in real estate, you need to go through the lengthy real estate transaction process for every investment. That means inspections, negotiations, appraisals, repairs, etc. It's not a set-and-forget strategy in any way.
- Higher barrier to entry: A single share of Coca-Cola costs just $54.64 as of the writing of this article, but a typical 10-20% down payment is tens of thousands. You can get started with stocks with just a couple bucks, but you'll usually need thousands to get started with real estate.
One major perk of investing in real estate is the ability to defer capital gains taxes using a 1031 exchange. Put simply, a 1031 exchange allows real estate investors to defer payment of capital gains taxes on a property sale as long as they use the profits to purchase another investment property.
With stocks, you have to pay capital gains tax every time you sell, even if you're planning to put the money right back into another stock. This can add up over time, especially if you're an active trader. Real estate investors, however, can sidestep capital gains taxes to a fairly large extent.
In the end, neither stocks nor investment properties are a golden ticket to wealth. Rather, true investment success relies on a well-balanced and diversified portfolio made of several different instruments, typically including stocks and real estate investments.