Build Wealth for Life: Real Estate vs. Stocks

I’ve been invited to give a presentation at the local Rotary club. Most attendees will likely have little real estate investing experience, so I decided to focus on the two primary methods people use to achieve financial independence. Before I continue, what does financial independence require?

Financial independence isn’t just saving a set number of dollars or a one time event. It’s about maintaining your current standard of living throughout your lifetime. To achieve this, you need an income that meets four requirements:

• Increases faster than inflation.
• Lasts your entire lifetime.
• Arrives reliably every month.
• Fully replaces your current income.

Before I Continue…

To keep this post reasonable in length (and readable), I will stay high-level and not dip into the technical details. So, I will not provide the background of some of my statements, but I am happy to provide the proof of all statements if anyone is interested.

Two Most Common Methods

1. Accumulate sufficient capital and, once accumulated, draw down from the capital.
2. Acquire sufficient (rental) income streams.

There are pros and cons to each approach. I will look at both in the next sections.

Capital Accumulation

The most common instruments for capital accumulation include stocks, bonds, mutual funds, CDs, etc. The concept is that once you accumulate sufficient capital, you can live off your investments for the rest of your life. How much do you need to accumulate before you can leave your day job?

If you plan to withdraw $10,000 per month for 30 years (the longest you or your spouse will live), assuming no market crashes, no investment returns, and no inflation, the calculation is simple:

• $10,000 / Month x 12 Months/Year x 30 Years ≈ $3.6M.

However, there is always inflation. If you assume that the average inflation will be 5%/Yr over the 30 year draw down period, and there are no market crashes, the amount you need to accumulate is ~$8M. (The calculation is somewhat complex but is available if you want to see it.)

$3.6M post-tax savings, let alone $8M in savings, will be difficult for most people to achieve.

Looking at the advantages and disadvantages of the accumulate and draw down method:

Advantages:

• Almost instant liquidity.
• You can begin investing with very little capital.
• You can monitor the value of your investments in almost real time.

Disadvantages

• Accurately estimating how long you’ll need your income—usually your and your spouse’s life expectancy. But what happens if either of you lives longer than expected and you run out of money?
• Accurately predicting future inflation rates.
• Consistently beating inflation and market fluctuations in the long term is nearly impossible.
• Taking monthly withdrawals reduces your investment capital, making risk diversification more difficult.
• Limited tax advantages.
• No/limited leverage

Next, I will look at income streams and rental properties.

Rental Properties

It is a well-known fact that real estate is a powerful tool for building wealth. I have watched many of our clients accumulate significant wealth (net worth) by buying and holding rental properties. The key to building wealth with real estate is appreciation. And that is determined by the city where you invest.

With real estate, the process is to accumulate sufficient properties that the net rental income fully replaces your current income. Depending on where you invest, you can achieve this overtime with very little capital compared to the accumulation and drawdown method.

Looking at advantages and disadvantages:

Advantages

• Inflation hedge: Historically, rents have increased faster than inflation while your major costs remain fixed. This means inflation can actually work to your advantage.
• Leverage: Most people will finance investment properties using a 30 year fixed rate mortgage. Fixed rate long-term financing enables you to acquire assets for a fraction of the total value.
• Tax benefits: Real estate offers unique tax benefits unavailable in other investments. For instance, you can defer taxes when selling one income-producing property to purchase another through a 1031 exchange. Another huge advantage is depreciation, enabling most people to shelter their rental income and possibly regular income as well.
• Wealth building: Cash flow pays bills but appreciation builds wealth. In a city like Las Vegas, you can reinvest accumulated equity to acquire additional investment properties through cash-out refinance. Many of our clients have used this approach to grow their portfolio.
• Income reliability: Buying a new computer, car, or kitchen appliance are all optional. Having a place to live is not. And, if you select the right tenant segment, major economic downturns have little or no effect on your rental income. For example, during the 2008 financial crash our clients had zero decrease in rent and zero vacancies. Even though property prices plunged, their rental income remained unchanged.
• Achieve lifelong financial independence with the least capital: if you invest in a city where rents and prices increase faster than inflation, you can achieve financial independence with a fraction of the capital compared to the accumulate and drawdown method.
• Simple: millions of people have achieved financial independence through real estate because it is simple compared to other methods. Real estate markets change slowly (compared to financial markets); instantaneous decisions are not required.
• Minimal time needed: With an experienced investment team, your time commitment is low and costs are similar to any realtor. Clients report spending just 8–12 hours total—including training—to buy their first property. Buying additional properties takes even less time.

Disadvantages

• Illiquidity: This is the biggest disadvantage of real estate. You cannot instantly convert your real estate holdings to cash. (This is why you need a balance between liquid assets and real estate.)
• Location and tenant selection are critical: Few cities can support lifelong financial independence. Additionally, tenant behavior varies widely. You need properties that attract tenants who stay long-term, pay rent reliably, and maintain the property well. Fortunately, selecting a good investment city and identifying the right tenant segment are straightforward processes.
• High entry cost: In an excellent investment city like Las Vegas, the entry point for an investment property that will attract the right tenant segment requires approximately $140,000 in cash plus a mortgage.

Summary

Every investment strategy has advantages and disadvantages. Real estate is the simplest and safest path to financial independence to my knowledge. Millions have successfully achieved financial independence through real estate investing and you can too. The process is straightforward and demands surprisingly little time. Most of our clients spend about 20 minutes each month, plus one annual review with us to determine if any adjustments should be considered.