Real Estate Investing Vs. Mutual Fund Investing

Those of us that love and respect Dave Ramsey have heard him say that there are two types of investments he makes on a regular basis. The first, being mutual fund investing based on his principals of diversification (Growth, Growth & Income, Aggressive Growth & International) and also paid for, in cash, real estate. This leads many clients to ask the question, should I be purchasing real estate within my global investment strategy and how does it compare to the investing I may be doing into mutual funds? Great question and let’s take a look below.

Before you dive into scenarios of what returns could look like in either mutual fund investing and real estate investing let’s discuss some basic foundational principals. First, I am assuming that the person considering buying real estate would be looking at a below $1 million property (commercial or residential) and would be buying the property after they have hit Baby Step 7 and are still actively contributing to Baby Step 4 and perhaps Baby Step 5 (if applicable). The investor would buy the property with all cash so as to not go back into debt therefore allowing the piece of real estate to be a blessing and not a potential curse. If there is a mortgage on the property and the rent stops paying for 3 months (which trust me can and will happen at some point) you don’t want to have to worry about finding the money to pay the mortgage. If you need a refresher on the 7 Baby Steps please visit Dave’s website to catch up.

Within real estate investing there are three types of return to be generated. Value increase (or potential decrease) of the property based on real estate values in the general proximity of your piece of real estate. Cash flow from the property which is derived from the rent paid to you from your tenant, whether they be a renter or commercial tenant. Finally, Deprecation of the property provides a tax incentive to own real estate because you’re able to depreciate the value of the real estate offsetting some the income, potentially saving you tax dollars. Stock Market investing most commonly would see only two of these three potential sources of return which are value increase (or decrease) and cash flow, to the extent the stock investment is paying a dividend (the shareholders portion of the profits paid to them).

Let’s run through a quick example:

Johnny buys a piece of residential real estate for $80,000 and intends to rent the property for $800 / month. After he accounts for maintenance and other potential repairs he plans on clearing for himself $600 / month. The property is in an area that has historically seen a 2% increase in real estate prices annually. The depreciation value is about $560 in tax savings.

Johnny’s annual return is 9.70% ($7,200 annual rent + tax savings) +2% appreciation on property = 11.70% return. If Johnny were to increase the rent to $1,000 and clear $800 / month, it would increase his total return to 14.7%.

Historically over the last thirty years 1991 – 2020 the stock market (using the S&P 500) has averaged 10.70% per year.

There are certainly things we didn’t account for within this example (renter trashes your home or real estate market crashes hence the value of the property plummets) but this gives you a general of idea of how one might consider the return of a piece of real estate against the mutual fund investing you might be doing through your advisor at Whitaker-Myers Wealth Managers.

One final factor to consider, is what is commonly called the “hassle factor”. Your mutual fund investments are not going to call and bug you about a broken dish washer or that they don’t like the curtains you put up in the living room. For some people, especially those that are not inclined to fix things themselves, this increased workload from their investments, which in turn could take away from family, relaxation or just general personal non-work time, might create a scenario where an investor may prefer to be in mutual fund options that just provide them a monthly statement and that is the extent to which they are bugged about the investment.

Real estate investing for the right person might provide them with an attractive risk / return opportunity, but certainly is not appropriate for everyone. Your advisor at Whitaker-Myers Wealth Managers is happy to discuss the pros and cons of this scenario in addition to modeling the potential real estate purchase in your financial plan.

Author: John-Mark Young

Whitaker-Myers Wealth Managers, LTD is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.