Real Estate Vs. Investing in 401(k)
Although 401k plans and real estate investing are completely different investment strategies, you can build substantial wealth over time using either strategy. 401ks are defined benefit plans made available to employees via their employer and real estate investing is for real estate investors.
Real estate investors think differently from employees. As a consequence, the investment choices and considerations are completely different. However, whichever strategy fits you, you can use a 401k or real estate investing to build wealth.
Accessibility
401ks are administered by, and accessible through, employers. Employees are able to invest a percentage of their before tax income into a 401k program where, in 80 percent of the cases, employers match employee contributions up to a specific amount.
For employees with this accessibility, no out-of-pocket expense is required. Contributions are conveniently deducted from their monthly paycheck. Real estate investing, on the other hand, often require large out-of-pocket expense in the form of a down payment or the cash purchase of a property.
For this reason, real estate investing is only accessible to real estate investors who have funds and/or collateral to work with. Many have tried “buy real estate with no money down” schemes, but most fail.
Tax Considerations
401ks have enormous tax advantages. For starters, employees can contribute with before-tax dollars. This reduces their tax burden beginning the first year they contribute and continues for every year they contribute. In addition, the contributions earn interest and dividend income is tax deferred.
Employees only have to pay taxes upon withdrawing the funds. If needed, employees can borrow from a 401k fund without any tax liability or early withdrawal penalty. The primary tax benefit available to real estate investors are the mortgage interest deduction and depreciation. These benefits are crucial to real estate investors as they grow their real estate portfolios.
Return on Investment
401k funds are normally invested in mutual funds. Although all mutual funds vary, it's safe to use 8 to 12 percent as a conservative return estimate over the life of the fund. This return is multiplied by the tax deferred interest and dividend income.
The return on investment can be substantial for real estate investors who use leverage to buy multiple properties and earn rental income from those properties as they build equity. If properly done over the long term and in the proper market, real estate investors can net millions, much sooner than someone relying on 401k investments.
Risk
401ks are generally a safe investment. Plus, employees benefit from the dollar cost averaging affect. By investing month after month, employees buy stocks internal to the mutual fund both when the market is up and when the market is down, thus “averaging out” the risk.
Real estate investor can earn millions much quicker than 401k investor, but they also carry the most risk from a fluctuating real estate market, high interest rates, destructive tenants, natural disasters and a host of other possibilities.
Best Practice
Although some employees moonlight as real estate investors, 401ks are best left for employees and real estate investing is best left to real estate investors with the resources and collateral to weather the storms. Whether you are an employee or a real estate investor, pick a strategy and stick to it. An employee who invests month after month into a 401k for 40 years, can grow a fund worth well over a million dollars.
