What should someone invest in? The Stock Market? Fixed Income Bonds? Real Estate? Let’s dig into the key differences between stocks, bonds, and real estate as investments. We will look at what each of them are good for, and what they are not good for.
A bond is a debt instrument. Whomever you buy a bond from, you are loaning them your money to use for a period of time in exchange for an agreed-upon interest rate on that money. The most common sellers of bonds are governments, like the U.S. Federal government, but other entities can issue bonds as well.
Based on the creditworthiness of the issuing entity, bonds get issued clear ratings by third-party watchdog agencies, based on their level of risk. The lower the risk assessment, the lower the interest rate tends to be.
Pros of Bonds:
- Fixed, predictable return on investment.
- Easy-to-understand risk ratings.
- Highly rated bonds carry less risk of loss.
Cons of Bonds:
- Potential returns tend to be low.
- Low-rated bonds can still have risk.
- Bond rates are susceptible to prevailing market interest rates.
A stock is an equity instrument. Rather than lending money to an entity, you are actually buying an ownership interest in that entity, usually a company. Over long periods of time, the stock market as a whole has far outperformed both inflation and the bond market. In addition to the potential for the value of the stock increase, windfall profits are sometimes passed on to stockholders in the form of dividends.
Warren Buffet famously said that he does the same analysis on a company whether he intends to buy the whole company, or a single share of stock, because the risk to his investment is the same. If the company tanks, the stock becomes worthless. If, however, the company catches fire, the value of the investment could soar.
Pros of Stocks:
- Potential to produce large short-term returns, as well as steady long-term returns.
- Stocks are highly liquid. If you need cash suddenly, you can usually sell stocks for their market value.
- Larger Shareholders may have a say in company governance and policies.
Cons of Stocks:
- Highly volatile in the short term. You could easily lose your whole investment.
- Company operations and financials that are very complex.
- Holders of small quantities of stock usually have little say in the operational decisions of the company.
Real estate is one of the oldest forms of investment, dating back to the Feudal era. Investors purchase the rights to exploit land and attached improvements i.e. buildings. These investors may attempt to improve the property and sell it for more than they paid for it (“flip” the property) or hold onto it for a long time, renting it to tenants to produce income.
Real estate could either be an equity investment (if you own some or all of the rights to exploit the land), or a debt investment (if you lend money to a property owner with the property as collateral).
Pros of Real Estate:
- Provides an avenue to organize a route to a safe investment portfolio you can grow as well as count on if done properly.
- Real estate is a unique asset in that every piece of land has its unique location and value.
- Potential to create both short-term cash flow and long-term appreciation.
- Property owners have control over the managerial decisions of the property.
Cons of Real Estate:
- Not a liquid investment. If you need to cash out, it might not be easy.
- If you invest in a fund like a REIT or a syndication, you may have little say in the managerial decisions.
- Subject to market forces as well as interest rates; also highly regional.
Want to learn more about Different Types of Real Estate Investments? Click HERE.