Real Estate Vs. Stock Market Investing: Which is Better?

Real estate vs stock market

I recently overheard two people conversing about real estate, which inspired me to write this blog. As their conversation progressed, one of the individuals said he stopped investing in the stock market because it required a lot of money to make money and was far too risky. He further proclaimed his house was a much better investment and real estate was the way to go. Given Canada’s current housing market, I can’t blame him for the statement.

But is real estate a safer and better investment than investing in the stock market? The answer isn’t what most people perceived it to be, and I decided to look at the data to support my hypothesis. As I started to do some research on comparing historical real estate returns to stock market returns, it occurred to me I was going about it completely wrong.

This wasn’t a number or fact base debate. I broke my own financial rule; financial well-being is less about arithmetic and more about emotional discipline. This is illustrated by the belief that real estate investment is safer and better than investing in the stock market. It’s a situation where there’s enough anecdotal evidence to warrant such a conclusion that we ignore the data that might prove otherwise. Therefore, each side more or less cherry-picks the only aspect of the date that helps their argument.

There are many reasons why people might perceive real estate to be a safer investment than investing in the stock market. I want to focus on three primary reasons contributing to the perception that real estate is always secure and a great investment.

Most people perceive or at least scrutinize real estate investment less thoroughly than stock market investing due to;

  • Inaccurate accounting of their total real estate costs;
  • Information overload regarding the stock market and;
  • Greater liquidity offered by the stock market

Let me explain what I mean by each of these.

Inaccurate Accounting of the Total Real Estate Cost

Most of us do not appreciate the actual cost of acquiring and maintaining a house. Most people view their real estate investment as a success if they can sell their home for more than they purchased it.  And while that’s not an accurate way to calculate real estate returns, we unconsciously think this way about our real estate purchases.

As a result, most people fail to account for the ongoing cost of maintaining their property. To them, ongoing expenses such as property taxes, insurance, mortgage interests, regular maintenance, and hydro/gas are not added back to the actual cost of the home.

When you purchase a stock, there’s one term you need to be familiar with called adjusted cost base (ACB). In short, ACB captures all the ongoing purchases, sales, improvements, and the initial purchase cost. For example, If I purchased a stock valued at $500 and then purchased an additional $100 worth of the stock, my ACB will now be $600. When I sell the stock, I will base my return on my new ACB of $600, not my initial $500, as I put in additional new funds.

The ACB approach also applies to purchasing a home. A homeowner buys a house with the initial cost being made aware but then has an ongoing investment cost they have to make to maintain and keep the home operating. However, most homeowners do not keep track of these costs and expenses diligently, which can provide an inaccurate account of the actual return of their homes.

When people talk about their parents who bought a house 30 years ago, they say, “my parents bought their home for $150,0000, and now it’s worth $750,000.” The statement translates to my parents making a $500,000 profit on their home purchase, which is false, but most of us accept this inaccurate accounting of real estate profit at face value.

That type of accounting makes real estate seem better than it is. Ongoing costs and all costs associated with the real estate purchase have to be included in the cost of purchasing a property to calculate the real estate return correctly. You can’t get a proper rate of return if you do not have all the costs associated with acquiring the property and maintaining it while you own it. If you buy a house at $400K and sell it for $450K, your profit isn’t $50K minus any realtor/ lawyer fees (one-time charge).

You have to consider all the costs you’ve paid to date, including the one-time charge and the ongoing expenses to keep the house. When both the one-time and ongoing costs are factored into the calculation, you get a true sense of how much it costs you to own that property, and your actual rate of return after expenses are deducted.

Too much information can be a bad thing at times

When it comes to the stock market, people are overloaded with information, fancy charts, and TV personalities constantly yelling at them for no reason. You can’t get up today without hearing about the stock market. Every 15 minutes, you’re provided with updates regarding the market. TV shows have so many red and green charts that I’m surprised they still have space for the host’s face. There’s a lot of information being thrown at the viewers. Since most people do not react well to change, investing in something they see change every 15 minutes makes people extremely anxious.

The constant update solidifies in most people’s minds that the stock market is volatile, and it can be in the short-term. The continuous update makes people less interested and deters them from investing as they perceive it to be too risky. It confirms their perception that stocks change too much and they will lose all their money.

Since stocks aren’t tangible, they figure why put any money into them. If they put money into the market, most develop a short-term view to make money quickly and then get out as they perceive staying for the long haul is bad as things change quickly in the stock market. They don’t invest but rather speculate to make quick cash, as that’s the mindset that information overload creates.

But imagine if you got an update on your property value every 15 minutes. How would that make you feel about your home? You turn on the TV and hear your property value has increased by 3%, only to find out on your drive to work it’s down 4%. When driving home, you hear on the radio that your property value has now dropped by 18% as one of your neighbors was running a meth lab.

How would the constant update about your real estate purchase make you feel? Would you become anxious?

My guess is most of us would feel anxious about our home purchase decision. The constant update would turn most people into speculators. People would naturally develop a short-term view of property ownership as a speculator. People would look for undervalued neighborhoods in hopes of cashing in big when the value goes up. This occurs now, but the practice would be far more prevalent.

Today, the stock market is updated on a per-second interval. As a result, we tend to have a short-term view and can’t look past one minute or one year on any investment purchase. This means most people are speculators and not investors when investing in the stock market.

The speculative behavior comes out of the need to act on information that’s being provided. And since speculation isn’t investing, most people fail at investing in the stock market because it becomes a game of chasing or picking the next winners rather than investing.

Lack of liquidity saves property owners from themselves

But even with the two things I’ve mentioned already, most people generally fair better at their real estate investment than their stock market investments. Why? Real estate investing forces them to have a long-term view regarding their investment, which saves most people from their emotional impulses.

Mortgages are amortized over a long period (25 or 30 years as of 2022), which forces people to take a long-term view on their home purchase indirectly. That means people generally do not buy a property to sell it in 5 years. That type of thinking is critical because it creates an investor rather than a speculator mindset. To successfully invest in the stock market, you require the same thought process and a long-term view.

For example, if your property assessment shows another year of decreased value, you generally don’t run outside and put up a for sale sign. Why? Selling a home isn’t easy, quick, or cheap. But more obviously, you shouldn’t sell your home since you would be selling it at a loss given its current lower market value.

However, with stocks, all it takes is a click or a phone call, and a few days later, you’ve sold what you don’t want. The stock market’s liquidity can be negative because we often act on our emotions before our rational side kicks in.

Since a home isn’t as liquid as a stock, you can’t quickly sell your home, even if you need to and want to. If your property value drops by 20% in one year, you typically don’t jump up and tell everyone you want to sell. Instead, you usually stay the course and hope for better days ahead. But stocks do not have the same built-in selling barrier system.

You can sell a stock with a click of a button. If your portfolio drops 20%, you panic, log into your account, and click sell. After you’ve made yourself feel good, you start asking legitimate questions such as, why did the stock drop? That’s the thing about stocks; it’s easy to make yourself feel good about making a terrible emotional decision. Successful investing requires a long-term view and acting rationally while assessing the situation that might impact your investments.

I’m not advocating that real estate is a bad investment because that’s not the case. I own real estate. I’m not advocating that investing in stocks is bad either because I own stocks. However, I encourage you to understand all the costs associated with what you are buying. In the case of real estate, that means both the one-time charges and on-going expenses related to the property.

Don’t talk about real estate returns with someone, and only factor in the one-time cost to make your point. There is a real risk associated with real estate and investing in the stock market. I have found that education plays a big part in making a good return. But even with education, you need to have a strong emotional disciple to tune out the noise. That’s what has worked for me, and that’s why I invest in real estate and the stock market because it’s unwise only to do one if you have the resources to do both.

Lasting wealth creation will require a combination of real estate and stock market investing. I believe real estate can be an excellent investment, and also I think stock market investing can be an excellent investment. You might be overweight in one area that plays more to your strength, but true wealth needs a balanced diet of diversification.

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