Clark isn’t against a more complex investing strategy. But he believes in behavioral economics. He likes giving advice that people are willing to follow. And advice that works for the highest number of people.
He’s a big fan of an index fund-based portfolio with a mix of domestic and international stocks as well as bonds.
Clark also likes Charles Schwab's "core and explore" philosophy, which allows for you to take risks or get creative with a small percentage of your portfolio as long as you're following the well-worn path of diversification, low risk and low fees with the rest.
He’s also personally invested in real estate over the decades. So although he tends to advise people to keep their investments simple, he doesn’t balk at other smart options.
But what does Clark think about putting money into real estate vs. investing? How do they compare? And is it better to earn income from a rental property where you also own the asset, or to take a long-term approach to the stock market?
I Hold $1 Million in Real Estate and Earn $70,000 Net Per Year. Should I Sell and Invest Instead?
I’m invested in real estate. Can I keep my money there? Or should I sell and put it all in the stock market?
That’s what a listener recently asked Clark.
Asked John in North Carolina: "I have $1 million invested in real estate (two single-family homes). That generates me a net of $70,000 per year.
"Many advisors say to sell and invest in the market a draw out at 4% per year. But that wouldn't even equal the returns I am getting with my homes. Let alone in the end I am left with a huge asset.
"With the equities and bonds approach I would have zero left when I am 95. Am I missing something?"
Managing a rental property and investing in the stock market are both viable money-making strategies. And they do have a common element of investing. After all, as John mentioned, you can own a house that you’re renting. And you hope that it appreciates in value over time.
But in other ways, comparing real estate vs. investing is like apples vs. oranges.
“You’re missing nothing, John. We’re talking about, though, two different things,” Clark says. “So it’s not reasonable to compare the two.
“Managing these houses is the equivalent of you working. Having a job. The other is having the money you have managed to save build future wealth for you and provide income for you that you don’t do anything to or for.”
Why Managing a Rental Property Isn’t a Passive Investment
Investing is by nature a passive activity. Especially if you follow a simple strategy (such as putting your money into a target date fund or into a small number of index funds and leaving it there for decades).
Managing an investment property is a job.
“Where you actively manage these two investment properties, you have to deal with repairing them. You have to deal with recruiting tenants. You have to deal with a tenant maybe not paying rent. A tenant who damages your place,” Clark says.
“You’re running a business. And if you’re running an active business, then you should be able to outearn what you could on passive investments.
“If you’re in stocks and bonds, you just can go online and see what you’ve got. That’s the sum total of work you have to do. Completely different.”
Real Estate vs. Investing: Consider a Compromise
What should John do? Should he leave the $1 million in the two houses and continue to rake in $70,000 per year? Or should he put the money in the stock market instead?
He referenced the 4% rule. You're probably familiar. But if you aren't, the 4% rule governs the amount of your total portfolio that you can withdraw each year in retirement. Some people say it's slightly too aggressive. Others say it's too conservative, at least during times of economic prosperity.
But the idea behind it is that if you take out about 4% of your portfolio per year, the rest of your investments will continue to grow. And you can maintain a steady lifestyle and income while making your retirement money last for decades.
There's some math that John can do (and that it sounds like either he's done himself or he's had a financial advisor do for him) to figure out how much money he'd be able to withdraw from an investment portfolio of $1 million annually.
John didn’t say whether he has a job, how old he is and when he plans to retire (if he hasn’t already). He also didn’t specify whether his entire net worth is $1 million and is 100% in those two rental properties.
Clark’s Potential Solution: Sell One of Two Houses
Especially if John has no other investment accounts, he could stand to be more diversified.
If one day he wants or needs to stop managing the properties for whatever reason, his real estate income will vanish. And he’ll need to sell one or both of the houses.
What if that happens during a low point in the real estate market? Or what if both of the properties are in the same city or neighborhood, and property values go down in that area?
Selling one of the houses now would help John lower his risk and get more exposure to the stock market while keeping some rental income and one of the homes.
“He could do a compromise. Sell one. Keep the other,” Clark says.
“And have the mix of the active investment of a house and the much more passive thing of just owning a portfolio of stocks and bonds that generate a hopefully reliable stream of income for you over the years.”
Final Thoughts
Making $70,000 a year from your rental properties, in which you also hold equity, is nothing to scoff at.
Like I said at the beginning of this article, there’s more than one path to financial success. And we all have choices.
However, selling at least one of the houses probably would give John greater diversification and lower risk. Not to mention it would reduce the amount of work and hassle that goes into managing the properties by half.
The post I Have $1 Million in Real Estate. Should I Sell and Invest It Instead? appeared first on Clark Howard.