Posted by Ryan on January 28th, 2008 in Investment Strategy
Let’s review the last six months of the US economy: Home values and prices fall. New home sales reach 12-year lows. Resetting mortgages push people out of their homes, destroying their credit on the way out. Home builders slow down construction as housing inventory reaches a 40-year high. The financial system takes a blow and economists cannot accurately predict the future. Fear and uncertainty set in as stocks tumble, rebound and tumble further. The Federal Reserve makes an emergency interest rate cut and the White House pushes a major plan to stimulate the economy as the media debates about whether the US will avert a recession.
For someone who has some extra cash they are anxious to invest, it’s tough to find some safe ground. Anywhere you look the housing slump and mortgage meltdown has affected investment returns, whether it be CDs, international investments, investment properties or the US stock market. Where is an investor to find a safe haven?
If you have the guts, there are some fantastic opportunities in both the housing and stock market. According to Money Magazine, over the next 2.5 years $233 billion in home values could be lost and an estimated 3.5 million homeowners will enter default on their mortgages. As a buyer in this market, this puts you at the upper hand to negotiate prices and pick up property on the cheap. On the other hand, price-to-earning ratios and other indicators suggest that stocks are also very cheap and will pay handsome returns to the long-term investor who can ignore the short-term whipsaws.
So What’s the Better Move – Investment Property or Stocks?
According to a 2004 Forbes.com article, real estate has surged 56% from 1999 to 2004 where the S&P 500 sank 6% during the same time period. But over the longer term, the S&P 500 grew 1,000% between 1980 and 2004, where home values only grew 247%. CNN Money also reported that stocks are the better deal for the long-term investor, with a 13.4% annual return in the S&P 500 versus an 8.6% average annual return in home appreciation between 1978 and 2004.
But there’s more to consider than just the return on investment. Let’s compare the pros and cons of investing in real estate versus the stock market:
Real Estate Pros:
- Buyer has greater ability to negotiate price and bid on foreclosures
- Borrowing money to invest is relatively easy and amplifies returns
- Rents go towards equity in the house and can provide additional cash flow
- Appreciation in property value produces additional equity
- Greater tax benefits on capital gains
- You can borrow against your home equity
Real Estate Cons:
- Hunting for the right property can be rather time consuming
- Land lording can create headaches
- Vacant properties, maintenance and repairs reduce profits
- High purchase costs/fees/expenses
- Housing Prices can continue to decline
Stock Market Pros:
- Buying an index fund involves minimal effort
- Little to no account maintenance. Just buy and hold
- Minimal purchasing costs/fees/expenses
- More liquid than real estate. You can sell and get your money out quickly
- Diversification
Stock Market Cons:
- Day-to-day ups and downs can have a psychological toll
- Borrowing money to invest is more complicated. Buying on margin is highly risky
- Volatility: Stocks can see dramatic movements that gain and lose money in relatively short periods of time.
- No tangible assets
While the current economic conditions are offering opportunities to purchase investments that can provide substantial long-term returns, you need to decide which option is most appropriate for your situation, ability, risk tolerance and overall investment strategy. If you are currently heavy on equities, consider adding some investment property to your portfolio. If you are just building up your nest egg, buying an index fund may be ideal in order to create a foundation of core, diversified holdings.
Millionaire Money Habit: Taking advantage of buying opportunities means having the guts to purchase investments that you see value in while others are apprehensive about them. Figure out the investment vehicle that is appropriate for you, and do your homework. You will certainly find some bargains during these times of panic and uncertainty. -RT
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