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Mutual Funds, Individial Stocks or Real Estate?


For Retirement, Should You Invest in Mutual Funds and Individual  Stocks or Real Estate?
By Kenneth T. Holman

Monday, August 8, 2011, was a terrible day for Wall Street and Americans who have invested much of their life savings in the stock market. After Standard & Poor’s downgraded American debt from AAA to AA+, the Dow Jones Industrials fell 634.76 points, the sixth worst drop since December 2008. The Dow was down 5.5 percent to 10,809.85, which continued an almost uninterrupted decline since late July when the Dow was flirting with 13,000. Last week, the Dow Jones industrial average fell almost 700 points. Counting Monday, the Dow has dropped in 10 of the last 12 trading days. It is down more than 1,900 points, or 15 percent, since July 21.
Every stock in the Standard & Poor’s 500 index declined Monday. The S&P 500 fell 79.92 or 6.7 percent to 1,119.49. The Nasdaq composite index fell 174.71, or 6.9 percent, to 3,257.69. With trading volume the highest since September 2008, about 70 stocks fell for every one that rose on the New York Stock Exchange. The Nasdaq and S&P 500 are both down about 18 percent since the end of April, while to Dow is down 16 percent.
The price of Treasurys rose sharply causing a plunge in yields. The yield on 10-year Treasury notes fell to 2.34 percent from 2.57 percent.
With all this bad economic news, are Americans better off investing in mutual funds and stocks rather than real estate?
Many Americans, who have the majority of their retirement funds invested in mutual funds, find they cannot retire with the income they expected when they first started putting their money into their Individual Retirement Accounts, 401(k)s or other retirement plans.
Here is the disturbing truth about stocks. In addition to poor performance on “Wall Street, commissions and management fees have historically eaten up all or most of the dividend income. Investors are left with only the growth in the stock itself or stock index to create growth in their portfolio. After expenses, in 8 out of 14 decades the compound growth rate was less than 3% for stocks that represent the S&P 500 Index. In fact, after expenses, there have only been 4 decades (1920’s, 1950’s, 1980’s, and 1990’s) in 110 years when the S&P 500 and the Dow Jones Industrial Average (DOW) have experienced compound returns of more than 5.5%, according to some experts.  
Over the past decade from 2000 to 2010, the S&P 500 has had an annualized return of .31% which means that over ten years, $1.00 grew to $1.04. Adjusted for inflation, the annualized return for the S&P 500 actually had a negative return of
 -2.07%; every $1.00 invested shrank to $.79. No wonder this decade has been dubbed, “The Lost Decade for the S&P 500” (Doug Short, Article: The Lost Decade for the S&P 500, July 25, 2011). This decade has been lost to whom? To investors, that’s who. Stock brokers, insurance agents, financial planners and bankers still got paid their management fees and expenses.
Most financial advisors need to sell their products or services to make a living. They can only sell what their company offers, which is mainly stocks, bonds, mutual funds, annuities, certificates of deposit and money market savings accounts. Financial advisors have no incentive to educate their clients about the impact that low returns, inflation, and market volatility will have on the client’s likelihood of having enough money to live out retirement. There is an inherent conflict of interest when the fox is guarding the hen house.
If most people fail to make money in the stock market, why is it they still keep investing and losing money? Does the stock market really offer compound growth of 10 to 12 percent? The resounding answer is no! A wise person once said, “The definition of insanity is doing the same thing over and over and expecting different results.” Investors need to stop the insanity of relying on the stock market for their retirement income.
Investing in stocks and bonds will not provide a safe and secure income for retirement. The stock market is an absolute train wreck. Volatility and poor performance are wiping out everybody’s retirement savings! Stocks are extremely volatile and do not provide predictable returns.
With the decrease in real estate values over the past few years, some may question whether real estate is a viable long-term investment alternative for retirement plans. Since 2006, real estate values have fallen in some markets by as much as 20 percent.
The decline in real estate values was due primarily to an imbalance in the market. Because of lax credit lending policies on subprime loans and easy money for speculators, supply outpaced demand. The market is now experiencing a correction of some magnitude. Once supply and demand come back into balance, the real estate market will return to a more predictable trend of price appreciation as inflation continues.
Even in this difficult environment, with interest rates near record lows, many real estate owners have been able to refinance and increase their cash flow. A typical real estate investment, even  without any appreciation in value, will provide net rental income of about 7%. I know several real estate investments that are generating returns of 7% and higher, even in these difficult economic times.
As secure long-term investments, stocks and mutual funds are very different from real estate investments. If there is insufficient appreciation in your stock portfolio, you can never retire. To continue to provide sufficient income to live on, you actually have to liquidate your stock portfolio over your lifetime.
Financial planners recommend to their clients to have a stock portfolio that is at least 25 times their first year withdrawal amount. This is called the 25 Times Rule. In theory, if your stock portfolio is large enough, by liquidating 4% of the portfolio each year, you should be able to live 25 years on your stock investments, assuming you haven’t underestimated inflation and the volatility of the market hasn’t wiped out your investment in the meantime.
Real estate, on the other hand, typically appreciates in value at the same time your tenants or lessees are paying down your mortgage. When you retire, the mortgages on your real estate investments have been paid down substantially which means your equity has increased. You don’t have to liquidate your assets to provide sufficient income on which to live, you simply live off the income your tenants pay each month.
If you don’t like managing your properties, hire a professional property manager. If inflation occurs, there is nothing to worry about because your rents go up at about the same pace as inflation. If you need a lump sum amount for an emergency, you simply borrow against your performing real estate assets.
In addition, because of the benefit of leverage and compound interest, you need less money invested in real estate to achieve the same retirement income by investing in stocks. Financial planners have the 25 Times Rule for stocks while real estate investment advisors have the 15 Times Rule for investing in real estate. The 15 Times Rule is that for every dollar you need in Net Rental Income, you need to purchase $15 worth of real estate (Jeff Sibel, CFP, The Real Estate IRA Retirement Planning Guide, p. 2).
To achieve an annual retirement income of $60,000, you can either invest $1,500,000 in the stock market, and have nothing to show for it when your portfolio is liquidated, or you can invest $900,000 in real estate and have several million dollars in appreciated real estate assets.
When it comes to having sufficient income for retirement, it seems pretty clear that real estate is by far the better investment choice.
Ken Holman is president of Overland Group, Inc., a company that provides real estate and related products and services to investors. He is also a Certified Commercial Investment Member (CCIM), a Certified Property Manager (CPM), a licensed Mortgage Loan Officer, a licensed General Contractor and Principal Broker for RE/MAX Overland. He can be reached at