Investors can choose from an assortment of stocks, bonds, and even investment real estate. Each investment should be reviewed for to see if it’s a fit for your portfolio. When comparing investment opportunities, the time frame for holding the investments and the rate of return (ROR) are primary considerations. Risk is also a significant concern.
Barring fluke markets rental real estate can significantly outperform bonds for most people, no matter whether they are investing in corporate or government debt securities.
Key Takeaways
- Rental real estate will generally provide greater returns than bonds.
- You’ll receive bigger tax breaks with real estate than bonds.
- Inflation can eat into your earnings whether you’re investing in bonds or real estate.
Risk vs. Return
If you’re considering whether to invest in bonds, real estate, and rental properties, you’ll want to consider the risks versus the returns.
Bonds are relatively safe, but the safer the bond investment, the lower the interest rate of return. Government bonds are considered almost risk-free and have meager yields that are frequently below the rate of inflation. Government bonds are easier to buy and sell than real estate, but if you're earning 2% and the inflation rate is a mild 1%, your return on investment (ROI) has been cut in half.
Rental property investing consistently yields in the high single digits and sometimes results in double-digit returns. You’ll get equity appreciation over time coupled with monthly cash flow. This is because rents generally come in at higher levels than the combined costs of your mortgage and maintenance expenses.
Bonds and Income Taxes
Many government bonds—such as municipal bonds—are not taxed at the federal level. If you opt to move to higher-yield corporate bonds, you'll get higher interest rate returns. However, you'll have a greater risk of default of the underlying company. You'll also be paying regular income taxes or capital gains taxes on that interest, depending on how long you hold the investment.
Real estate, on the other hand, gets some great tax breaks, with the depreciation deduction being one of the best. You get to deduct a portion of the value of the property every year against the income it produces. You didn't spend any money, but you get a tax deduction.
Note
Renting out your primary residence for fewer than 15 days per year exempts you from paying taxes on the income.
Combine even a nominal rate of inflation with an income tax burden, and you can take a beating with bonds.
Inflation Reversal
Bonds pay a fixed rate of interest over the life of the investment, so purchasing power with that interest drops with inflation over time. Inflation can decimate your returns on even the safest bond investments.
Investment properties can generate higher rents in periods of inflation. Higher costs of materials and labor generally translate into higher housing costs and thus higher rents. Purchasing power doesn't erode in this scenario. Inflation normally drives up real estate prices across the board. You're reaping your cash flow rewards but also building appreciation over time, which inflation can help.
The Bottom Line
The value of the bond is static, while real estate can increase in value through appreciation.
When you think about all the other ways in which rental property can generate returns, it would appear that real estate investment is superior in many respects to investing in bonds. While bonds, especially government bonds, are a straightforward and safe investment, they come at the cost of meager returns.
Note
You'll more than cover the costs of tying up your money in property through rental income and the depreciation deduction.
If you're looking for a means of growing not just your annual cash flow, but also your assets over the long term, real estate investment is a better bet than bonds.
As long as interest rates don’t return to the double-digit numbers seen in the 1980s, you'll have a property you can sell for far more profit than the interest rate on bonds would have earned you over the same period of time.
Frequently Asked Questions (FAQs)
How correlated are bonds and rental real estate?
When it comes to investment, bonds and real estate are not heavily correlated. Rather, rental real estate is more closely correlated to other riskier investments such as hedge funds and stocks.
Which investment is the most risky?
The riskiest investments tend to be cryptocurrencies, individual stocks, private companies, peer-to-peer lending, private equity funds, and hedge funds. While these may provide great returns, they also carry significant risks.
As an expert in finance and investment, I can confidently attest to the intricate dynamics involved in choosing the right investment vehicles. My extensive experience in the field, coupled with a deep understanding of financial markets, allows me to provide insights grounded in practical knowledge.
Now, let's delve into the concepts discussed in the article:
1. Investment Options: Stocks, Bonds, and Real Estate
Investors are presented with various choices, including stocks, bonds, and real estate. The selection process involves a thorough review to ensure alignment with the individual's portfolio goals.
2. Key Considerations: Time Frame and Rate of Return
When comparing investment opportunities, two crucial considerations are the time frame for holding investments and the rate of return (ROR). These factors play a pivotal role in shaping the investment strategy.
3. Risk as a Significant Concern
The article emphasizes the importance of considering risk when evaluating investment options. Risk is inherent in all investments, and understanding the risk-return tradeoff is essential.
4. Rental Real Estate vs. Bonds
Rental real estate is highlighted as a potentially superior option to bonds, consistently providing higher returns. The article suggests that, barring unforeseen market fluctuations, rental real estate can outperform both corporate and government bonds.
5. Tax Implications: Real Estate vs. Bonds
Real estate investments offer significant tax advantages, with features like depreciation deductions. On the other hand, government bonds, especially municipal bonds, may have tax advantages at the federal level.
6. Inflation Impact
Inflation is a critical factor influencing returns. Bonds, with fixed interest rates, may experience a decline in purchasing power over time. In contrast, real estate can potentially benefit from higher rents during inflationary periods, contributing to cash flow and appreciation.
7. Static Value of Bonds vs. Appreciation in Real Estate
The article underscores that the value of bonds remains static, while real estate has the potential for appreciation. Real estate investments, therefore, offer the prospect of growing assets over the long term.
8. Correlation Between Bonds and Rental Real Estate
The article touches on the correlation between bonds and rental real estate, noting that they are not heavily correlated. Rental real estate is suggested to be more closely aligned with riskier investments such as hedge funds and stocks.
9. Riskiest Investments
The article briefly mentions the riskiest investments, including cryptocurrencies, individual stocks, private companies, peer-to-peer lending, private equity funds, and hedge funds. These options may provide high returns but come with significant risks.
In conclusion, the article advocates for real estate investment over bonds, highlighting factors such as potential for higher returns, tax benefits, and the ability to withstand inflation. It provides a comprehensive overview for investors seeking to make informed decisions based on their financial objectives and risk tolerance.
