There will always be a hot conversation in the personal finance community about investing in real estate vs stocks. I do both, so today I’m gonna share details about two of my long-term retirement assets.
Asset #1 is a Rollover IRA account. The current balance is about $109k. Asset #2 is a buy-and-hold rental property I’ve owned for five years. Coincidentally, it’s also worth about $109k!
Although both of these investments are worth almost exactly the same amount as of today, they’re in different asset classes, have different risks, and one is a passive investment while the other is constantly managed.
Over time, I think it’ll be fun to track their individual growth side by side and see which one we might be able to call the “better investment” in the long run.
Ultimately it doesn’t matter to me which one outperforms the other because I already own both and will hold them for the long term regardless. But I hope it’ll be an interesting journey for you to follow and help answer some questions … and maybe help me prove out an overall hypothesis. More on that below!
(Also, note that anytime I use the words “me, my, I, or mine” about these investments, I really mean “ours.” All of the assets I talk about are co-owned by my wifey!)
Asset #1: Index Funds in a Rollover IRA
I have an IRA account with Fidelity. The money inside this account is a result of two past employer 401k programs. When I left these old employers, the 401k funds were rolled over into this regular IRA account. I haven’t touched or contributed to this account since I left my last employer two years ago, and because I don’t have a current 401k plan, I won’t be contributing more to this rollover account for a long while — the initial investment amounts are on their own to appreciate for now.
The current balance (as of 7/1/2020) is $109,602.
This is invested entirely in a total stock market index fund, which gives me a diversified portfolio without any of the work of creating one. The balance represents about 1,250 shares of FSKAX. (For you Vanguard lovers, this is Fidelity’s equivalent to VTSAX). All dividends are set up to automatically reinvest in the fund, and it will all compound over time.
I’m anticipating that this account will grow at an average rate of about 9% per year if left untouched. Only time will tell what the actual returns will end up being — nobody can predict the future in stock investing! I’m assuming this 9% growth rate based on historical returns and not taking any inflation into account.
The thing I love about index fund investing is there’s no effort involved. It’s a set-and-forget stock investment that doesn’t take any physical or mental energy to maintain. I wish I invested more in the stock market earlier, but I only moved to the USA 12 years ago and was late to learning the 401k game!
Asset #2: A Buy-and-Hold Rental Property in Texas
In mid-2015, I bought my first out-of-state rental property in Texas. It took about 10 months of research before finding and closing on this place, and it’s been a steady little wealth grower ever since. This property is cash flow positive, with incoming rents exceeding the outgoing expenses.
The property is worth about $220k right now. Between the latest tax-assessed value ($220k), comparable properties in the area (values range between $180k to $250k), and my local real estate agent’s “feelings,” a $220k valuation seems like a fair market price.
I have an outstanding mortgage of -$123,708 for this property as well as an emergency fund checking account with $13,334 sitting in cash. All of the rental income is deposited into this checking account, and all of the expenses are taken out of it.
All in all, this asset is currently worth $109,626.
Real Estate Property Growth Potential
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 oversimplify it by breaking down the growth into three categories.
This rental makes money three ways:
1. Loan pay-down. Because the tenants are covering my mortgage payment, there is a small amount of the loan balance being paid down each year. This year in 2020, the loan balance will go down by about $2,820.
2. Positive cash flow. This property brings in $1,975 of rental income each month but has expenses of about $1,750. So that’s about $225 of positive monthly cash flow, or $2,700 per year. Sometimes it’s more, sometimes it’s less, but this is the average.
3. Appreciation. Over time, real estate prices in the area should rise, and this house should be worth more and more. My best guess is that it will increase by about 2% per year. Of all the assumptions I’m making, this is probably the biggest. There are a million reasons why property prices become more expensive — faster in one housing market, slower in another — and my way to calculate this was very conservative. My guess (and minimum hope) is that this property will appreciate at the same rate as general inflation.
In total, I estimate this property will increase by $2,820 (loan paydown) + $2,700 (cashflow) + 2% of property value for this year. Which is about $9,920 this year.
Since my current equity is $109,626, this puts the growth rate at around 9% (return divided by equity). This return % will float up and down a little year by year, but at this time, it’s my best estimate of future growth.
Tracking Real Estate vs Stocks Over Time, Comparisons, and Questions I’m Pondering …
So we have two completely different assets, both currently worth about $109,600, and both hopefully growing at about 9% per year. Let’s forget about tax and capital gains for a moment … Here are some things I’m wondering:
- If left untouched, will they both be worth the same amount in 10 years? What about 20 or 30 years?
Maybe, but probably not. Because the index funds involve zero management, the return will be whatever it turns out to be. There’s not much I can do to affect the price of the overall stock market.
For the rental property, there is a lot I can personally do to affect the returns. I can raise rents, refinance the loan, negotiate expenses, make profitable upgrades to the property, etc. All of these things might deliver me a higher return.
On the flip side, if I neglected or poorly managed the rental property, I could drive my profits into the ground. Many a new real estate investor believes rental properties are passive income investments. Left unattended, profits accidentally slip away over time. Future returns depend on the investor’s ongoing actions.
- Which one will outperform the other?
Only time will tell. I will certainly try my best to make sure the rental property is managed correctly. But I truly have no idea which will grow faster. (And capital gains tax will have a major effect if and when I decide to sell either of these assets.)
- If the real estate investment outpaces the IRA, will the excess growth be worth all the hassle/time/risk that goes into managing the investment property?
This question keeps me up at night.
Let’s say I bust my balls and manage the rental property like a rockstar for the next 10 years. After years of staying diligent and efficient, I might achieve a 10% annual growth rate instead of my projected 9%. Over 10 years, the difference between 9% and 10% is an additional $25k in value.
Is this extra $25k worth all the risk and monthly hassle that goes into managing a rental property for 10 years? What if the difference was only $10k? Honestly, I don’t really think the extra $ is worth it. Rental properties are hard work. Plus, if I ever sell the place, it could cost me $25k in commissions and transaction costs just to sell it!
- If I can achieve “similar” returns in index funds vs. the rental property over the long run, why invest in real estate in the first place?
Back in my 20’s, I was hungry to make money and passionate about real estate. If there was a choice between a simple path and a hard path to build wealth, I would choose the hard path. (I have a subconscious philosophy that choosing the harder routes in life is more rewarding, even if you fail.)
But now, as I mature more and learn about risk-adjusted returns, I’m feeling that the simpler path to wealth might be a better choice. Why make it harder than it has to be?
While I am still pro-real estate investing, I’m hesitant to blatantly advise others to go out and buy rentals willy nilly, without fully understanding the long-term commitment and ongoing hard work of owning an income property. That’s an investment strategy I don’t endorse!
Real Estate vs Stocks … Let’s See How Things Grow Over Time!
I hope that tracking both these assets publicly will help give you some insight into the different ways index funds and rental real estate property can help you build wealth over time. Also, I’ll do my best to talk about the *effort* that goes into managing residential real estate as an investment and share stories along the way.
We’ve had a whacky 2020 so far, which is making the stock market do weird things. The real estate market is also being affected, and it’ll be interesting to see what happens the next few years.
More to come on all this. If you’ve got any questions for now, throw them in the comments below and I’ll do my best to answer!
*Image by Nattanan Kanchanaprat
Joel is a 35 y/o Aussie living in Los Angeles and the guy behind 5amjoel.com. He loves waking up early, finding ways to be more efficient with time and money, and sharing what he learns with others. Rise Early | Retire Early!