With high housing prices and rents in major US cities, many young professionals wonder if they should invest in real estate or max out their 401k for retirement savings. This article compares the tax benefits and historical investment returns of real estate vs 401k to help readers make an informed decision.
Real estate provides more tax deductions but has higher transaction costs
Owning investment real estate allows deducting expenses like mortgage interest, property taxes, repairs and depreciation from taxable income. However, buying and selling real estate incurs substantial transaction fees for lawyers, loans, taxes and more. 401k contributions reduce taxable income like deductions but have no transaction fees.
The long-term returns of stocks have historically outpaced real estate
Data over the past decades shows that equity indices like the S&P 500 have significantly outperformed real estate returns. While real estate also provides value appreciation, the higher transaction costs dilute some profits. Over a 20-30 year horizon for retirement savings, stocks are likely to generate higher compound returns.
Real estate income may provide better cash flow but has risks
Rental income from real estate investment can offset owning costs and provide spendable cash. However, finding good tenants, properly maintaining properties and handling vacancies/evictions are significant hassles. The stock market does not provide regular cash flow but has performed strongly over most long periods despite volatility.
REITs allow easy real estate investing in retirement accounts
Buying publicly traded REITs within IRAs and 401ks provides both diversification and real estate exposure without the headaches of being an individual landlord. REIT dividends receive beneficial tax treatment in these accounts compared to taxable accounts, boosting investor returns.
Balance and diversify both real estate and equities
Every investor’s optimal allocation differs based on their income, time horizon, risk tolerance and more. But over-exposure to any single asset category creates concentration risk. Balance real estate, stocks, bonds and cash in suitable proportions for retirement assets and other investment goals.
Real estate and 401k/IRA retirement accounts both have pros and cons from taxes, costs and returns perspectives. Diversifying across both provides stability and growth potential for investors focused on the long run.