As financial advisors, we receive questions about all types of investments. Here’s one we recently heard:
I am a doctor, and many of my friends and fellow doctors are getting into real estate. There is a group that invests in local deals in our area, and it is easy. All I have to do is write a check (no property management, no upkeep, dealing with tenants, realtors, leasing agents, etc.). What are your thoughts on investing in real estate?
It could be a sign of the times or where we are in the economic cycle, but questions about real estate keep popping up, especially from investors in Colorado. This is a stark change from2008 – 2012 when no one wanted to go near real estate. That’s when prices were inexpensive and investing in real estate made sense. Today, with prices up significantly, that’s not the case.
Before I can address whether real estate investing would be a smart thing for the doctor, I ask a few simple questions:
Have you maxed out your 401(k) or SEP/IRA?
Have you maxed out a “back-door” ROTH IRA? (This can be a smart move for people wanting tax-free compounding, but are excluded from a ROTH due to high compensation or maxed out 401(k) or SEP/IRA.)
Have you paid off your high-interest debt?
Have you paid off your mortgage?
Are you funding college for your children?
Are you making contributions to a taxable investment account, and taking advantage of the lower tax rates on dividends?
Do you have enough cash for emergencies?
Do you have excess cash flow where you spend less than you bring home monthly?
If the answer is “no” to any of these questions, then putting money into real estate or any other alternative investment may not be wise. Checking off these items first is smart for most savers, especially before investing in something for which they may not have expertise, experience, or what I like to call a “Natural Advantage.”
This stems from a simple idea: understand your “Why.” What is the Why for each of your investments? What do you want to gain from each?
As with any investment, some people are interested in cash flow or income, while others may be looking for price appreciation. This is true regardless of how you invest (real estate, stocks, ownership in businesses, etc.). However, certain investments may offer strengths in one area and weaknesses in other. Investing in the S&P 500, for instance, provides price appreciation and a small dividend income. Investing in real estate keeps up with inflation on average, making it a poor choice if you’re hoping for price appreciation. Unless you’re good at timing market cycles or taking on risk with leverage such as borrowing money to make that investment, you may want to stay away from this. Interesting how people forget how leverage works against investors when prices fall.
With an understanding of your “Why,” ask yourself these questions:
How will you invest? There are many different ways to invest today. You can buy direct ownership of companies via their common stock, or through others using methods like Electronically Traded Funds (ETFs). With real estate, you can buy, own, and manage properties on your own, invest in syndicated pools, or invest in publicly traded Real Estate Investment Trusts (REITs). Anything more complicated than a REIT typically requires additional time and effort, and results in less diversification and liquidity. Taxes are also a consideration with each of these structures.
What are my risks? A significant risk with private real estate is the lack of diversification. Essentially you are putting your faith into a single region, city, area, type, and economy. It takes a decent portfolio of properties to gain any level of diversification, especially when compared to a basket of stocks. This holds true for those investing in the private stock of a company compared to publicly traded shares. Diversification and liquidity are essential items people may not consider. If things go wrong, these can make or break a portfolio.
How does this investment fit into your overall financial plan? Real estate is an investment, so it needs to be considered along with your other investments as part of your financial plan. You might believe that real estate helps to diversify a portfolio of publicly traded companies since their values may not move in the same direction as the broader stock market. While this may be true, the headwinds of liquidity and determining the value can be problematic. Stocks, on the other hand, are priced every day, from 7:30 am – 2:00 pm MT. You can see, buy, and sell them – all from your phone –at a moment’s notice. Liquidity can be an advantage as well as a disadvantage.
What is your edge or expertise? This might be the most critical question. What do you know about this area and type of investment? Any investor should be able to answer this about all of their investments. Do you have expertise in this area? Do you understand precisely in what you are investing? If not, are you outsourcing this expertise to someone with the right insight, experience, or knowledge? Are their interests aligned with yours?
Questions like those posed by the doctor often lead to more questions, and not simple answers. The key is to understand your “Why.” Know why you want to invest in something before asking if you should. This simple principle can help keep investors out of trouble and on a better path to the goals in their financial plan.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
https://prosperion.us/wp-content/uploads/2017/02/whitelogosized.png00Steve Boorenhttps://prosperion.us/wp-content/uploads/2017/02/whitelogosized.pngSteve Booren2019-02-17 13:21:132019-06-18 12:10:46Improving Investor Behavior - Know the "Why" for your Investments
The average American spends more than 85 hours per month watching TV. The same person will likely spend about 265 hours sleeping and 228 hours working. Know how much time they’ll spend working on their finances? About 1.8 minutes, (yes, that works out to 96 seconds) per day.