Ever wondered why real estate investing is so popular? Or do you know why income tax reform is such a contentious issue? Or why you hardly ever hear anyone in their 20s talk about retiring with a “pension” one day? Our economy is changing rapidly, and we have to learn to adapt with it, especially if you want to live a comfortable life. Remember the words of
Let’s start with those pesky “wealthy” people. Often the rich are portrayed as negatively in the media as the poor who take advantage of the System. You see them in the large houses, flaunting their opulence, appearing on Robin Leach documentaries. However, the vast majority of the rich do very little of these things. Most drive regular cars, live in regular homes, and all don’t work at Goldman Sachs type jobs. Many own their own businesses and are just the proverbial Average Joes.
But the one thing that these guys do different than others is their money management skill. Consider the following income tax rate structure:
Income Tax Rates for Select Income Types
| A. Salary/Income | 25% |
| B. Capital Gains Income | 15%* |
* These rates apply only if these investments are held at least one year.
Now, let’s say that you could control the money you had flowing into your possession. Which tax rate would you prefer? If you’re sane, you’d probably choose (B). Capital gains taxes are taxes levied on income gained through investments—the sale of securities (like stocks or mutual funds) and/or real estate. So those who pursue wealth try to maximize B while (legally) minimizing A when reporting income to the government. You can reduce (A) through tax deductions, and maximize (B) by working to increase your holdings in interest-gaining investments. So if for some reason you are in a rush to retire for some reason it is generally easier for most people to get there using the Real Estate option than investments. However do keep in mind that real estate does pose greater risks than investing in stocks/bonds/mutual funds.
So, keep in mind that the more income type (A) increases, the higher your tax rate can go (up to about 35%). However, as your Type B income increases, the tax rate generally stays the same. If you reach a point where your investment income is high enough to equal or exceed the amount of Type (A) income you receive, the lower your tax rate will be (generally). And if this amount is high enough to cover your expenses every month without dipping too heavily into your Type (A) income (your salary) it will place you in a powerful position of financial independence. This is yet another reason to consider socking away income for your later years as you move up in income.
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4 comments:
Nice post. However I'm confused why you think RE investments are greater risks than stocks/bonds/mutual funds. History (the Tech-stock market bust) has shown us that paper investments can be very risky. In a paper investment, your putting trust in a fund, company or bond and hoping that those in control will grow the fund exponentially. Lack of control sounds risky to me.
In reality RE investments are physical investments that you have more control over. You can add to its value by using your own creative ideas to increase its worth.
I'm not saying RE is risk free but everyone should understand that all investments are risky without proper knowledge. None less than the other.
Actually, stocks and mutual funds are the superior return investment. Stocks have returned about 10% over the past 25-30 years, and about 8% since 1928. So that includes 3 major stock market corrections--in 1929, in 1987, and in 2000. With those returns included, 10%.
Real estate and housing by comparison hangs around 6%. Plus you need a helluva lot more money to leverage yourself. Keep in mind also that its easier to invest 10,000 than to go borrow $150,000 and make sure that you buy correctly. Don't get me wrong, RE is a great investment, but over the long haul, stocks are at the top and are more liquid (convertible to cash). If I own stocks and my car breaks down (and for some strange reason I don't have an emergency fund), its far easier and quicker to sell stocks for cash rather than trying to sell off rental property.
the 10% return is a myth perpetuated by the media and financial institutions.
Ben Stein has offered proof in 'yes you can time the market' that over any 20 yr period the stock market has returned any average 8%.
If you can hold RE for any 20 yr period buying with 10% down, i'm sure you'll do better.
but if you make over $100k from your salary, you may not have the time to learn about RE investing nor the inclination. Just because stock investing is easier doesn't make it better. RE investing is more difficult, but you will find the returns (and tax treatment) can be superior if you know what you're doing.
Hi AIMM,
Thanks for stopping by. As for the real estate thing, you're right in that you have to know what you're doing, but RE generally returns less than stocks over the long-term. Plus its highly illiquid. Witness the "subprime meltdown" that the media is cycling through now. People who "knew what they were doing" by buying more house than they could afford in hopes that it would all work out in the end are feeling a little pain right now, because they cannot downgrade without losing money.
Again, I'm not knocking RE--I think it's a great investment. Just saying that if I invest in index funds over a 20 yr period versus someone who flips real estate or rental property, chances are that I will make out better, and with a lot less worry.
However, that's just the Law of Averages. There will always be high-flyers who are superior RE investors, there will be poor stock-chasers, and there will be a handful of folks who can "time the market." Most everybody else fall in the middle somewhere.
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