Should I Invest In A 401k or Real Estate?
TL;DR - Real estate provides massive earning potential and control over your investments. A 401k can be more passive but is very limited.
When we're looking to invest our money, we're more than likely thinking about retirement, and it's about playing the long game. And of course, we want to make as much money as possible.
Two of the most popular investment types are 401ks and real estate, and these two investments are proven to be reliable and carry you into retirement. But, there remains the big question - which should you invest in?
Retirement: 401k vs real estate
They Both Have Merits
Neither of these options - 401k or real estate - are bad. In fact, that's the reason we're going over them in this article.
Either way, you're investing in your future, which is something that we applaud at Undoor.
However, there are pros and cons to both 401k and real estate investing. We hope that through the information you'll learn in this article, you'll come to your own conclusion about what's best for your future.
Without further ado, let's get to it.
Pros and Cons
The benefits and advantages you get by investing in real estate will not be the same as 401k investing.
There might be some overlap, but each investment type is unique in its own right.
401k
A 401k is a pension account - essentially something you put money into for your retirement, and the goal is for your money to appreciate over time.
There are two types of 401ks. The traditional and the Roth.
The traditional 401k is when you put money into an account without paying taxes upfront. When you take out the funds for retirement, you'll pay taxes on any contributions made at that time.
A Roth 401k is the opposite. You pay taxes upfront on the money you deposit into the account. Then, when you take the funds out for retirement, you get them tax-free.
Pros
Taxes - For a traditional 401k, any money you contribute to your account is tax-free income. That means that you get to invest and avoid paying taxes on that money. Legally, of course.
Employer Matching - Often, the company you're employed by will offer to match whatever you contribute to your 401k. I think we can all get behind that.
Passive - You deposit funds into your 401k and watch as they appreciate. If you get a financial advisor to do that for you, it's even easier.
Cons
10% Penalty - If you touch the funds in your 401k before retirement, you'll get a 10% penalty on the amount you take out.
No Cash Flow - You're essentially putting money into an account you can't touch until you're 59 1⁄2.
Deposit Limits - The government only allows you to invest $20,500 a year into your 401k account. Your gains are limited.
While there are some great benefits to 401k investing, the drawbacks are equally harsh.
Real Estate
The options are limitless with real estate investing, and you can get so proficient with it that you can make a living (and then some) through it.
In fact, you can build such a robust investment portfolio that you won't need to worry about retirement at all.
Residential properties, commercial properties, and land are just the beginning of your massive earning potential through real estate investing.
Pros
Returns - While a 401k might earn you a 7%* return, expect anywhere from a 10-25% return on your real estate investment.
Zero Penalties or Limits - Unlike a 401k, there is no penalty or limit for investing - and taking home - as much money as you want in real estate. Of course, tax implications remain for the income generated and/or property sale.
Leverage - You can purchase real estate using loans. At zero to little out-of-pocket cost to you. The significance of this can't be stated enough. You can earn money by using other people's money.
Tenants Pay Mortgage - That loan you just used to invest in real estate? Yeah, you don't have to pay for it. The people you rent your property to will do that for you. Not only can you buy real estate with little cash, but you can get tenants to pay your mortgage.
Great Cash Flow - So, your tenants will pay your mortgage and the expenses associated with the property you now own. In addition, you'll likely take home some money after all your bills are paid. It may only be a few hundred a month, but you're getting paid money to invest in your future. Pretty cool.
Cons
Can Be Hands-On - Real estate is a more active investment than a 401k. You might have to find new tenants and such. However, you can hire out your property management to someone else - negating this con entirely. That is how we do it at Undoor.
The pros seem to outweigh the cons of real estate investing heavily.
Comparing The Two In Numbers
Here's for you analytical types - a comparison of the two, using numbers.
This is very simplified but will illustrate the difference between investing in a 401k vs. real estate.
Let's say our target is to reach $1,000,000 in retirement assets over 30 years.
401k
Using a simple compound interest calculator and assuming an average 7% 401k return starting from $0. You would have to contribute $883 every month for 30 years to reach the $1,000,906.49 in 401k retirement. That is $317,880 of your own money you would have to save over 30 years to reach your retirement goal.
That would then allow you to live off of the recommended 4% yearly draw from the 401k, which equates to $40,000 per year.
Real Estate
Now, let’s compare that to real estate.
Real estate has more factors at play, but here’s an example using one of our Undoor investment properties.
We are assuming the following relatively conservative numbers:
3% yearly property value appreciation
2% yearly rental income increase
2% yearly expenses increase
6% selling costs
This property was purchased for $132,000 with a 20% down payment of $26,400 on a 30-year fixed loan.
It rents for $1,600 per month. We currently put aside 75% of that for maintenance, property management, reserves for extensive fixes, property taxes, insurance, loan payment, etc.
In 30 years, this property will be paid off and worth an estimated $424,771. It will have generated a cumulative, free, and usable cash flow of $231,584, or an average of $7,719 of free usable cash per year.
If we sold this property after 30 years, the sales proceed after selling costs would be $399,285. If you add on top of that, the cumulative cash flow, the total profit of this property of 30 years would be $594,284!
Now, think about that. You need $26,400 for a downpayment (yes, plus closing costs, but we're keeping it simple here) to end up with a total 30-year profit of $594,284.
If you do that twice, your total out-of-pocket investment funds would be $52,800, and after 30 years, you would have $1,188,568 in retirement funds.
The Breakdown
401k - save and invest $317,880 to retire with $1,000,906.49.
Real estate - save and invest $52,800 to retire with $1,188,568.
Now, which one do you prefer?
So... Which Investment Is For You?
As you can see, investing in either a 401k or real estate can provide you with immense benefits.
It's up to you which one aligns with your goals more.
A 401k can be more passive but provides less upside and control than real estate.
While it can be hands-on, real estate offers substantial earning potential and authority on your investments.
How We Can Help You
Does investing in real estate sound intriguing to you? Would you like to learn more? We'd love to be of value!
At Undoor, we pride ourselves on teaching new and experienced investors how to maximize their gains with minimal stress. Our goal is to help you fall in love with real estate and real estate investing. What we're most passionate about is maximizing investment gains for people like you.
Do you want to get key insights and advice that'll help you get ahead of the game? Don't hesitate to contact us for any and all real estate wants or needs.