Originally posted by @Joe Splitrock:
Originally posted by @Preston C.:
I'd have to agree with the initial post. The majority of people would be better off investing in the stock market. Real estate investing requires one to get good deals. If you're buying at market, or even just slightly below market, you're better off putting your money into the stock market.
Something most people don't figure in when comparing the two is compounding. Annualized returns in the stock market are year over year. Meaning if you put $100 now and it is worth $110 the next year, your second year return would be based off the $110. The historical 10% average people often talk about is an annualized return, so what you actually earn on your initial investment would be much higher as time goes on, because compounding is figured into the 10%. For example, if you invested in the S&P 500 exactly 30 years ago, your annualized return would have averaged about 6.93%, but your return on your initial investment very year would have averaged about 21.56%. Of course this varies a lot depending on the period when you actually invest (If you waited a year based on the example returns would go to 7.72% year over year and 28.66% annual over your initial investment). For real estate to compound (other than appreciation and raised rents), you have to do all the work yourself to make this happen and reinvest into more real estate with your earnings. Stocks have this built in because the companies that represent them grow the companies for you.
Of course, like it was mentioned before this is apples to oranges, but as far as long term investing goes, stocks are better for those who don't want to work at it. Real estate is better for those that want a steady income stream and don't mind the work involved with it. For me, I'd rather spend the extra time to find good deals and reinvest in real estate. Meanwhile, it is also not a bad idea to invest in stocks and add to tax deferred retirement accounts.
Can you clarify a little? At first you said the stock market has 10% annualized return. Then you said 6.39% annualized return. Then you said your return on investment every year would average 21.56%. Warrent Buffett says for the market as a whole expect 6-7% taking into account dividends. Maybe he is wrong, but it seems closer to your 6.39% historic number.
I would be careful using the average return, because it can be deceptive. It is how mutual funds and financial advisers trick people into thinking investments are better than they are. You can average years with large gains and years with large losses and the average looks good. In fact you could have a five year investment with average positive return and end up with a net loss.
The difference between annualized and average return isn't really due to compounding. Interest in a bank account is compounding. Stocks just go up or down in value. Like a house value goes up or down. Annualized return is just a way to normalize the numbers to evaluate true performance.
A better comparison may be rents to dividends. In that case they both need to be reinvested.
Another trick I have seen used on mutual funds is that when they calculate annual growth, they include deposits.
My point is just be careful what numbers you are using to evaluate investments.
I tried to keep that post relatively short, so I thought there might be questions. What I meant was that stocks have sort of a built in form of compounding. Companies don't attempt to grow at a rate based on their initial values, but year over year. What I was trying to clarify was that annualized returns that are advertised with mutual funds or other stock funds are year over year returns. Say you invest $100 in a fund averaging 10%, you'll get $110 the first year, $121 the second, $133 the third, and so on. As long as the fund keeps earning about the same, the return multiplies year after year (I know its not this simple with fluctuating returns, this is just for the example). The 10% is just a figure that I've heard before when people talk about historical returns. The 6.39% I actually figured myself using Yahoo Finance and going back 30 years, which was year over year. The 21.56% was figured by taking the total return from 1987 to now and dividing by 30 years, representing a return over the initial investment, not year over year. I know average can be deceptive, as stocks can have huge fluctuations, but I just used it for comparison.
The reason I used this for an example was to show the difference in rental property over stocks. Say you buy a $50k house with cash that cash flows $10K per year, assuming slow appreciation and steady rents it will earn about 20% every year over the initial investment. That return can't really be compared to the stock market annualized returns because each annual return in the stock market is based on the prior year's value, not the initial value. But if you take the cash flow every year from the house and reinvest it, your return over the initial investment will begin to multiply. With stocks, companies reinvest their earnings internally and grow themselves. But of course, if they pay dividends its up to you to reinvest earnings.
Sorry if I'm doing a poor job explaining, this is just something I'd figured on my own when trying to compare a rental property I have to stock market returns. I know stocks don't actually compound like money in a savings account, but I was just trying to show that there is sort of a compounding effect built in. This example also doesn't really take into account different forms of financing available for real estate and how you can leverage returns. It gets pretty tricky comparing the two since there are tons of different strategies. It really comes down to what you prefer and what you're good at.
I'd like to also add that I'm not trying to come across as pro-stock market, because I actually prefer real estate. But for a strictly passive investor, its hard to beat a good stock fund. I also don't claim to be an expert investor in either, this is just my opinion based on my own investing and research.
