When one has cash to invest, two of the most considered options are the stock market and real estate. The underlying motivation is to have your money working for you without the risk of losing it. Think of it as having cash take the place of you driving to work. My father referred to this process as “learning to make money while you are sleeping.”
The concept is simple: identify an amount of capital that you will not need for the necessities of daily living. Invest this money for the purpose of (1) generating income and/or (2) creating wealth and leverage through appreciation (the increase in value of the investment over time).
INCOME
Some stocks generate dividend income. The annual rate of return on your investment is ultimately tied to profitability. On average, the annual dividend income generated by stocks appearing in the Dow Jones Industrial Average is 4.09% (http://www.indexarb.com/dividendYieldSorteddj.html). The average rate of return on real estate investment property is greater than the Dow Jones Industrial Average, but typically below 10%. However, the cash-on-cash return (the rate of return on the actual cash invested) for income-producing real estate can be significantly higher (refer to INVESTMENT CHARACTERISTICS below).
Another source of real estate income is a secured loan: a Promissory Note secured by a Deed of Trust. These collateralized investments generally yield over 10% annually with negligible risk when competently researched and originated.
APPRECIATION
The Dow Jones Industrial average and the median home price in San Diego have each appreciated approximately 835% since 1977, the earliest reliable data for tracking median home prices in San Diego County. The average yearly appreciation over this 31 year period is about 28%.
INVESTMENT CHARACTERISTICS
To realize a return on stock investments, one typically uses capital to acquire the investment. Real estate is usually 50% to 80% financed with borrowed money at rates that represent the lowest cost of investment money available to the average consumer.
The advantage of investing in stocks is liquidity. Stocks may be converted to cash quickly. A real estate equivalent, trust deeds, can also be converted to cash, but usually at a discount. However, quality, seasoned deeds may not require a discount to liquidate and are a collateralized source of predictable income.
The advantage real estate has over stock as an investment is collateral. If a stock’s value plummets, the investor is left with a worthless asset and little hope to recover lost capital. The real estate investor is left with the rarest commodity available to be owned: part of the planet.
Another advantage to real estate as an investment is the potential for much higher returns through leverage. For example, if an investor were to purchase a property, an annual return of 28% can be anticipated. If the property is financed with 50% down, the gross yield on the capital, or cash investment, would be nearly doubled: the appreciation will be the same with half the amount of cash invested. The gross annual yield, in this example, would be 56%, less the interest cost of the borrowed money. In today’s mortgage market the cost of borrowed money has been holding steady at about 6%. As such, the actual annual yield to the real estate investor would be roughly 50% on a collateralized investment (gross yield of 56%, minus the cost of borrowed money 6%). Moreover, the interest expense may be deductable from the investor’s tax liability, increasing the actual yield to the real estate investor.
For these reasons, and many other good reasons, real estate is a secure foundation upon which wealth can be acquired and sustained easily within one’s own lifetime.
