Real Estate Vs. Mutual Funds

Real Estate Vs. Mutual Funds


Financial planners often spout the benefits of stock market “diversification”. You might hear: “Lets invest you into some well selected mutual funds, diversify to limit your risk, I will take my little piece for my brilliance, and you will be fully prepared for retirement when the time comes, - as will I from siphoning off some of your cash at every move you make”. He usually leaves out that last part.

OK, first, as a former Registered Investment Adviser with a Masters Degree in Wealth Management, I understand the benefits of diversification better than most. No one should put all of his eggs into one proverbial basket so to speak, that is not rocket science. Unfortunately, financial planners rarely mention the single best investment anyone can make, and that is invest into well selected, personally owned rental real estate.



Lets assume and understand for a moment that real estate and stocks increase in value at about the same historical rates. Why would one want to own real estate when it is obviously more work than watching mutual funds or stocks grow at a similar rate virtually unsupervised? Why subject yourself to the occasional nightmarish tenant, the leaky roof, and other annoyances that come with managing real estate? Isn’t it a lot easier to just invest into good quality index mutual funds and relax?

Real estate isn't for everyone.

Real estate is not as easy as passively investing into stocks or bonds. It is a part time job. We have to keep in mind however who actually pays for the investment. If you’re willing to do some work, make this your part time moonlighting job, then unlike buying into into mutual funds or stocks, you can get someone else to happily and gratefully invest large chunks of their money into your personal retirement plan.

Stocks and mutual funds don’t work that way. I tried to get other people to pay for my mutual funds, but you know what? - they didn’t have any reason to want to – so I had to buy all of my own with my own money. They did fine, but something was missing – the benefit of other people’s money funding my retirement for me. I had to find a way to entice other people to willingly fund my retirement – real estate.

Tenants will eagerly pay for your real estate if it is well selected and you provide a safe and decent place to live. It is not the same with stocks and bonds. The only other way I know of to get others to pay for your retirement is to call your uncle at the state house and get a no-show government job. But hopeful that gravy train is slowing.



Real estate requires some work. Sure, buying stocks and mutual funds takes work too, but not the same kind - get a new tenant, (maybe even evict a tenant) arrange for a new AC system, call the plumber to fix the leak kind of work. It gets easier the more you do it, but it is absolutely more work than the stock market – but for 5 times the reward or more. Is it worth it to you? If you think it might be, here are a few simple rules:

Like anything else, it takes time and you will need to have patience. You will find that the rewards will be far greater than the stock market if you follow some simple rules and keep to your program. Real estate is not easy, you must be active - but few things worthwhile ever are. The good news is that just about everyone is capable of succeeding in real estate if they want to do so.



Stocks and bonds generally do pretty well over time, - so does personally owned real estate. Both return about 8% or so, but not necessarily at the same times. There are always some good years and some bad ones along the way for all.

For this example we will start with real estate not appreciating at all - that’s right, we will compare real estate at ZERO appreciation to stock market appreciating at a low 5 percent. And lets project out about 15 years.

We put $20 thousand into good mutual funds and $20K into real estate with an 80% mortgage ($100K property).

First advantage is that we buy $20K of stock and $100K of real estate because we obtained a mortgage as most people will and should do with rental properties.

The tenants pay the mortgage over this period, there may be several tenants, and even some vacancies, but we factored that into our purchase analysis and between rent and mortgage, taxes, insurance and repairs, we break about even with our 15 year mortgage, not including the tax benefits of depreciation.

Over fifteen years the Stock will double if we appreciate only about 5% - just math. So it will be worth about $40,000.

But remember, we have the real estate at ZERO appreciation, so it is worth still just the $100,000 we paid for it – but since the tenants paid the mortgages and other expenses, your equity in the real estate has increased five fold when the stocks only doubled – without considering any real estate appreciation.

The stock may have provided income along the way, and the real estate probably did too, either in cash flow or tax savings. Lets call that a wash.

What if real estate matched the stock investment as it usually does over time? Well, your property is now worth $200K (original price times 2) and your mortgage is again completely paid off, so you have 10 TIMES your original equity investment because you only used 20K of your money to reach 200K value fifteen years later.



The stock valued at 40K is now converted to income. (Lets ignore the tax consequences of selling the appreciated stock). You do well and get a 5% income return from a new income portfolio you selected. 5% of $40K portfolio is $2,000 a year income.

The rental property should also produce at least 5% rental income after expenses. 5% of $200,000 is $10,000. Additionally, unlike the stock conversion to income orientation, the real estate is still appreciating at whatever rate the market dictates. Real estate automatically converts from a growth investment to an income investment when the mortgage expires.

Real estate is a long term investment but it goes through phases. There is the accumulation phase, at which time it is a growth investment providing little income. after the mortgage is retried it immediately shifts to an income source, but it at the same time it does not sacrifice growth as it will continue to grow at the market rate because your house has no idea whether or not you are still paying a mortgage.

When comparing mutual funds to real estate, it is very important to understand that the real estate is like the pharaohs pyramids – it is forever, forever providing income, forever requiring some maintenance, but if taken care of, never depletes when you withdraw the income from it – it just keeps growing.