Real Estate vs. Stock Investing: How Do I Allocate My Capital?

Question

Hey everyone. I just wanted to see what sort of response I could get to this question as it's something that's confused me for a little while now. Thank you in advance for all of your responses!

Sorry if I come across as naive but I'm fairly new to the world of investing and, when I have the monthly income to do so, I want a better understanding of how to allocate that income to various investment options.

My question is this: how do you all personally decide where you might put your extra income in a given month? Let's say that you have $3,000 left over in a given month (after all expenses) to go back into your assets. How do you personally allocate that money in regards to going toward an index fund/IRA or a future real estate investment?

I know there is unlikely a hard and fast strategy to this and I'm sure it comes down to personal preference but I'm curious what sort of standards other individuals follow as it comes to their investments.

Again, thank you all for your time. It is greatly appreciated!

Paul Shannon · Answer

There's not really a right or wrong answer to this question.  I agree with others who've mentioned that you can't pass up putting as much as you can (up to the limit) into tax deferred accounts.  At a minimum, if you receive a company match, contribute at least the amount that allows you to receive ALL that free money.  You can do a self-directed IRA and invest in almost anything with this money, but a traditional 401K will be stocks/bonds.  That's what I have, so that's what I do.

With taxable accounts (what's left over), it comes down to risk tolerance and having a plan that you can stick to no matter what's going on with the markets.  Diversification is good.  Stocks, bonds, real estate, different asset classes even within real estate, precious metals, and cash.

I think of these assets as separate buckets of water.  When a bucket's water gets poured out, ie the stock markets most recent dip, I'm filling it back up.  Buying low.  If real estate starts feeling the pain in 6-12 mo due to COVID via foreclosures, etc, I'll be filling that bucket.  Right now I'm filling the cash bucket.

Taylor L. · Answer

Regarding stocks: I heard early on, I believe on Motley Fool, that we shouldn't make a stock investment with less than a 5 year time horizon. So if we plan to need the money back out in 5 years or less, just keep the cash. That strategy is intended to make up for times like right now, where the market is way down.

I max out my tax advantaged accounts, then keep the rest in cash for real estate investments. I think it comes down to your personal goals, timeline, risk tolerance, and activity level. Someone with $3k left over per month is probably in a higher tax bracket, so the tax savings of a 401(k) (solo or otherwise) is a pretty good deal.

Justin Windham · Answer

@Cole Holloway

I think it's a good idea to maximize (or at least utilize) contributions to tax-advantaged accounts such as IRAs and 401ks. Some folks on these forums prefer to divert that money to real estate instead, but there are IRAs and 401ks that can be invested into real estate, so the two worlds don't have to be mutually exclusive.

As for non-retirement money, most people will have a preference as to what asset classes they hold. Around here, real estate is very common, but many people will diversify into traditional assets too. I think a mix of safe investments and growth-oriented assets makes sense. I like real estate because good returns can generally be safe too, especially with proper due diligence before an investment. I'm actually starting to look into investing in other areas of the country since our area is fairly expensive and, in general, doesn't offer the best cap rates. There are places where getting rentals to cash flow is much easier.

John Williams · Answer

@Cole Holloway, I'm glad to see that someone else is asking the same question. I've been torn trying to decide how to allocate capital.

Over the long run, the stock market returns 7-10%. And the Vanguard Real Estate ETF (VNQ) has returned 9.1% since inception. So it seems that I'll need to find real estate which generates a cash-on-cash rate of 9%+ if I want to exceed the returns available in the stock market (and that's not even factoring in all the time and effort that goes into a real estate investment).

Frankly, that's the only reason I haven't invested in real estate yet. I've found it difficult (in my local area) to find properties with a cash-on-cash rate exceeding 9% (except for rehab properties, but my full-time job keeps me too busy to fix-and-flip).

I'll be interested to hear other people's opinions on the matter. It seems to me that real estate investing doesn't make sense unless you can get a cash-on-cash return in the double digits.

Steve Vaughan · Answer

@Cole Holloway  We first fund anything with a match to max the match.  Retirement / HSA.

Then max Roth's.  Some years we don't qualify and have to go back door.  If so, then not as important.  We wait and play what-if at EOY depending on whether we sold a property or not.  Some years it makes sense to do traditional IRAs, then convert to Roth in a down market and or income year.

After the basics, we as a group tend to fall into 2 camps - RE or paper equities but most have both.   I used to have more in stocks but through growth now have about 94% RE.

its hard to maximize returns in RE pre-purchase. Safety and liquidity is the purpose. If I knew when an opportunity would arise, I could invest the dry powder.  Lost lots of returns keeping the dry powder account safe in a money market acct.

I miss the passivity of mutual funds but like the control, leverage and ability to buy RE below market value.  RE has a steep learning curve but can be utilized over and over once mastered.

Becca Summers · Answer

@Cole Holloway I'm always saving up for my next downpayment for my rentals. We do 15% into our 401k and that's it. For me the 401k is the back up of the backup plan. However, the 401k does make a good account to have for reserves when buying rentals. I'm sure there are better but we keep the downpayment in a money market account making a little bit.

Daniel McNulty · Answer

@Anthony Jasmine

You are on the right track, but seem to have the cause / effect a little backwards. The fed doesn't actually cause inflation or deflation, rather the economy naturally experiences it for far to many reasons to list here. In the near future, inflation will likely be caused by the monumental increase in money supply. The fed raises and lowers rates in normal times to keep the economy heading towards its inflation target of about 2% annually.

On the horizon, if you believe inflation is likely, you would expect the fed to raise interest rates (at some point, probably after employment numbers rebound substantially). With that in mind your long term bonds would lose value as rates rise. That is not to say your long term treasury idea is bad in the short to medium term, but your rates to value relationship is off if you are thinking over the long term.

Anthony Jasmine · Answer

Something that I've been thinking about (Granted, I'm not sure if I got this down yet)- but I would invest the extra cash flow into a long term treasury bond ETF. Preferably I'd use vanguard. When the fed wants to increase inflation, they will lower rates which in return raises the dividend yield of the bond, but lowers the sell price of the bond. When interest rates rise to create deflation, the dividend yield lowers, but the sell price will rise. That way, you'll collect nice dividend yields during inflation, and when deflation hits... you can sell the bond ETF at a high price and buy new properties in a buyers market. I'd like some opinions on this as I still don't know if I have this correct.

Daniel McNulty · Answer

@Cole Holloway

There is some solid advice here. Collecting free money from matches and maxing out retirement accounts is often the cheapest and easiest thing to do, especially if you are in a high tax bracket.

As @Paul Shannon alluded to, his bucketing approach is the perfect analogy for re-balancing and allocating your resources where opportunities arise in the short term.

Stealing Paul's analogy, in the long term,there is no hard and fast rule on how to properly size the various buckets. General rules of thumb are younger folks should have much larger risky buckets like public equities / real estate / etc. (say 60 - 80%). Older folks may have smaller buckets of risky assets. The only consistent thing you may find is to have 6-12 months living expenses set aside for the average person (potentially more if you are older).

To make a long story short, pull out the ol' excel spreadsheet and see where you land. Set a target by asset class and head that direction with your monthly excess income or by re-balancing.

Cole Holloway · Answer

@Taylor L. Thanks Taylor! I appreciate the response and this definitely helped clear it up a little for me.

Real Estate vs. Stock Investing: How Do I Allocate My Capital?

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