“Should I Invest In Real Estate? Or Buy Stocks?”
A reader writes:
“My spouse and I are in our late 60s and we’ve wanted to buy an investment property near our home for a long time. Our current home is almost paid for and we have no consumer debt.
“I’m looking to make a move on the condo purchase with IRA funds, but have not done it yet. Looks like if I rent it fully for 12 months I would have a 6.7% return. Of course that goes down if it is rented less or if unexpected repairs happen. My question… do you think a 6.7% is a decent “relatively safe” return. Based on what other similar condos in my area have sold for, I am buying at or just above the market. I normally would not do this, but they have a new HVAC, windows, appliances, ceramic tile, plumbing, etc. With all this new, I doubt I will have to make a major repair. My goal would be to hold on to it for five years.
“I have also thought about instead of this condo, looking at oil stocks like Mobil-Exon (looking at the graft, they are a bit down and my guess is it will go up), but I am not a player in this area. Anyhow, do you offer any thoughts here?”
My answer on both questions would “Not yet”. You have a lot of work ahead of you before you’re ready to invest.
I’m concerned that if you leap in now then you’re going to experience a huge hassle and lose some money (and lose a lot of sleep, too). Before you invest in either asset, you should educate yourself on both types and learn more about the risks.
I’ve answered this sort of asset question at least 50 times over the last few years. Readers have good ideas, but some of them lack an overall plan. We investors should first answer the questions about goals and timelines and then learn more about each type of asset. Then we need to do the hard and detailed analysis before we buy. If we’re not willing to do the work then we should stick to passively-managed index funds with low expenses. Even if we’re willing to do the work, we should limit real estate and individual stocks to a portion of a diversified portfolio.
Two types of readers ask me about real estate. The first type is hard-wired to succeed. They grew up with real-estate investors, or they’ve put months of effort into learning about it. Their questions tend to include a detailed analysis of the property’s value, its neighborhood, its rent potential, its flaws, its risks, and its finances. They’ve dug into all the expenses, built spreadsheets, and figured out how they’d handle several scenarios. They’ve learned from reading books and websites like Joshua Dorkin’s & Brandon Turner’s Bigger Pockets or Frank Gallinelli’s free Real Data resources. They might be a first-time investor or they might be an experienced landlord, but they’ve done their homework and they’re asking good questions. We discuss the quality of their data and the history of the property’s neighborhood and the likelihood of the investment scenarios. Usually they’re not asking whether they should buy it– they’re asking whether they’ve missed something or how they could justify offering a lower price.
The second type of reader hasn’t done their research yet. They wonder whether they’re missing out. They might ask: “I’ve wanted to invest in a rental property for a while, and somebody told me this one is a good deal. It looks like it’ll make more money than my CDs, but I don’t want to take a lot of risk. Should I buy it?”
These readers have not educated themselves and they have not done their due diligence on the property. The answer has to be: “No, you don’t understand what you’re getting into yet. You shouldn’t do this because you may be exploited by tenants, property managers, and realtors. You’ll lose money.” If they’re buying “at market” then they’re paying too much. As the experienced real estate investors have learned, you earn your profits when you buy the place at a discount– not when you hope to sell it at a new market high.
The big red flags are the reader questions about the returns (including a decimal point). No landlord expects to rent their property for 12 months per year, none of them would ask whether that investment is “safe”, and no projection would be so precise. Instead they’d calculate a range of capitalization rates or internal rates of return based on at least one month’s annual vacancy. (Some pessimistic lenders assume three months.) They’d have the property professionally inspected and develop realistic repair estimates (even when it’s new). The landlord would also analyze market rents and property values and understand how their projected return compares to the local area. “Safe” comes from understanding the finances and minimizing the risks.
The reader’s question about an individual stock is an even bigger red flag. It’s the wrong question because, frankly, they’re window-shopping and attracted to shiny objects. We investors should focus on goals, time horizons, and asset allocation. We should be researching the industry and sharing analyses and asking whether we’ve missed anything. Investors who want to buy individual stocks should first write their investor policy statement for their portfolio (a key tool of Bogleheads investors). Then they have to figure out how an individual stock like Exxon-Mobil would fit into their asset allocation with a diversified portfolio.
Other alarming indicators from readers are comments about graft and statements like “a bit down” and “guess it will go up” and “player”. Their analysis seems to be based on media headlines instead of hard data. The Dividend Growth Investor would spend several hours researching the oil industry, Exxon-Mobil’s track record, their future prospects, and their ability to sustain a dividend. They’d also consider how any individual stock fits into their overall portfolio diversification, and then they’d set a target price for their first purchase of the stock. They’d even buy the shares over several months to cautiously build their intended position.
This reader’s question shows that they’re not investing in real estate or stocks– they’re gambling. It might work out better than a casino or lottery tickets, but they should understand what they want to do with their savings before asking whether to buy an asset.
Where can people learn more about investing?
Read the Bogleheads Wiki topics on “Getting started” and asset allocation. Readers may already know the investing vocabulary, but these pages will help figure out what you want to do and then help you put together a plan. Once you’ve sorted out your long-term goals and your preferred asset allocation then you can decide how you want to implement it. I’d suggest a diversified portfolio of passive index funds with low expenses. You can own real estate through a REIT fund and you can own Exxon-Mobil as (a tiny) part of a total stock market fund. Or you can diversify through an actively-managed fund like Vanguard’s Wellington or Wellesley– their expenses are lower than most active funds and the managers rebalance to stay within their asset allocation. If you’re in the military or federal civil service then you should start with the Thrift Savings Plan and the world’s lowest expenses. You can find equivalent index funds at other financial corporations like Fidelity and Schwab.
Real estate and stocks can reward you with inflation-beating returns, but that’s a product of time and effort. It’s straightforward but it’s not easy, and they’re usually more risky than other asset classes. If you can’t make the time to put in the effort, then you’re better off investing in (once again!) passively-managed diversified index funds with low expenses.
(Thanks to Ellie Kay for suggesting this post!)
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