Episode 174: Exploring Investment Assumptions: Real Estate vs. Stock & Bond Investing

Ever wondered why real estate investments can feel more comfortable and confident than securities investing? Melissa Joy  dives deep into biases surrounding real estate and investing in stocks and bonds. She shares her observations from conversations with clients as well as her own experience in real estate vs investment returns of various indices over time. Melissa unpacks the reasons behind these assumptions and sheds light on the broader discussion about investments in general.

Resources:

• Learn more about Melissa Joy, CFP. ® and  Pearl Planning .
• Read Take Control of Your Finances in 2023: 10 Actionable Tips for a Secure and Prosperous New Year.
• Listen to Episode 162: More Than Money with Melissa Joy, CFP®.
• Register for our Summer Economic Update and Investment Outlook Webinar. 

Links are being provided for information purposes only. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Pearl Planning cannot guarantee that the information herein is accurate, complete, or timely. Pearl Planning makes no warranties with regard to such information or results obtained by its use and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation. Please note, changes in tax laws or regulations may occur at any time and could substantially impact your situation. Pearl Planning financial advisors do not render advice on tax matters. You should discuss any tax matters with the appropriate professional. Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results.  It should not be assumed that your Pearl Planning account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Pearl Planning accounts; and, (3) a description of each comparative benchmark/index is available upon request.

Transcript

Speaker 1: 0:04

Welcome to the 52 Pearls Weekly Money Wisdom Podcast. I'm Melissa Joy, a certified financial planner and founder of Pearl Planning, and I'm Melissa Friedenberg, financial advisor with Pearl Planning. Pearl Planning is a financial planning and investment management company located in Dexter and Gross Point, michigan. We work with clients all around the country. The purpose of our podcast is to explore specific financial topics and provide advice you can use in your everyday life.

Speaker 2: 0:38

Welcome back to the 52 Pearls Weekly Money Wisdom Podcast. It's Melissa Joy here today And I have a topic I've been dying to kind of unpack and discuss with you, so I hope you enjoy the ride. Today We're going to talk about kind of biases when it comes to your assumptions about what does really well with investing, and I was prompted to do this because of several clients who have recently commented on how they feel very comfortable and confident when it comes to real estate investing because their real estate investments do quite well And they feel less so when it comes to investments in securities like stocks and bonds. Each conversation I kind of just listened they've come up several times recently and were quite insightful and important. I loved hearing client experiences, client preferences, but then each time I also followed up by kind of digging in after the discussion to say, hey, i'm curious what those numbers look like, because in most cases there were specific investments that were the client's examples to say here's why I believe in real estate investing. And there were very specific instances of I own this property for these periods of time and these were the results I got. So we're just going to unpack that conversation And I think it both is specific to how you think about real estate investing and how many people think about that, whether it's your own home or investment properties, and I also think it gives you insight into a broader discussion about what it means for investments in general, and sometimes familiarity brings comfort and confidence. With investments in stocks and bonds, there's less clarity, you can't see the four walls of the stocks and the bonds, and so I think that this discussion is a great example of a broader discussion. I'm going to take a pause here and just mention that it is summer and I'm reporting this episode outside, so if you hear any birds or outside noises, you're not hearing things. I'm home with a sick kid and instead of hearing you know the kid's screens in the background and decided to record outside. So to get started, kind of laid the table about what I wanted to discuss and talk about, i just think it's important to acknowledge that many, if not most, of you have experience with real estate investing, whether it's as a renter, where you see other people owning investments, or for many of us, we own primary residences.

Speaker 2: 3:16

In some cases we own additional properties, maybe a second home, maybe an income property or a vacation home, and nowadays it's really easy to see the numbers. We can see hey, i looked up Zillow or Redfin and I think my home's worth this. Or you can see your neighbor's prices. There's clear price discovery about how things are being bought and sold in real estate markets, and so you know. We have the same information available when it comes to stocks and bonds every day. For most of the things that you own, you can see a price every day, but those prices are in a per share value, which is more difficult to kind of compute than when you own one house. You have an indivisible, in many cases, property And so you have a valuation that you know. Hey, i originally bought this house for whatever the number 500,000, a million or 100,000 and today it is worth this number, based on what my neighbor's house sold for or what the Zillow says and things like that.

Speaker 2: 4:22

So to get started, there's that. You know, first, that many people have experiences with investing in real estate and they may feel more confident in those experiences because they often did their own research, of course, to make a decision to purchase a home or receive a home and inheritance, and certainly in many, if not most, cases, real estate ownership is quite hands-on. So you know the inside outs of the property and what goes into it. So sometimes familiarity and comfort can lead to increased confidence, just a behavioral kind of insight. And so I think it's important to remember that for many people, real estate may feel more safe and more comfortable because they have had this big experience of ownership, and so you know that, i think, certainly plays into the idea that I'm more confident here versus there. To take you through a clear example of this unpacking kind of the returns of a real estate investment, i want to expose myself, and I think I've been a pretty good real estate investor.

Speaker 2: 5:32

You may say that timing had a lot to do with it, but I had just had my first child in 2009. And, if you remember, the real estate market was quite low at the time. There was, you know, despondency and depression when it came to real estate prices. There was very little inventory on the market because so many people were underwater on the value of their homes. But we had just had a child and the condo that was my first ownership that I'd purchased before I married my husband felt very small at that time period. We were underwater with that condo as well, and so we turned that into a rental property and happened to find a great house and subdivision in Michigan where I live, and we're able to purchase a 2,400 square foot home in a nice subdivision in our town for $220,000. And we made that purchase in the spring of 2010. So I know these numbers I'm going to pick on myself because I've always, you know, kind of felt like, hey, give myself a pat on the back. I did quite well when it came to that investment.

Speaker 2: 6:41

Now, of course, we were going to be living in that home, so we also were able to forego rent, which we would have had to pay to someone else if we were to have moved into a home that we did not own. But we also picked up some costs. So we had the cost of property taxes, we had to maintain the house, we had to pay utilities And we had our original transaction. We had commissions and fees that were associated with the transaction to pay the real estate agents and to close, and then, of course, in our case, we did not pay cash for our property. We had a mortgage And so we also had the cost of a mortgage. But I've always felt quite proud or perhaps in many cases, fortunate or lucky that we were able to purchase a home at that period in time Because, of course, compared with today, home prices were much lower, and so we were able to sell that house and move to a different house last fall, and while we had originally paid $220,000, we sold the house for $525,000.

Speaker 2: 7:50

That felt like a really great, you know, profitable investment, and that was the way we were able to close things out. And if I were to guess today because the real estate market in Southeast Michigan is still quite hot and there's very little inventory in spite of higher interest rates I think that that home value may have even gone a little bit higher, and so I'm going to assume that probably, the home is worth about $550,000 today. Now I know, hey, that feels like a home run and that feels really concrete and gosh, isn't that like an outstanding investment? shouldn't I be patting myself and my husband, my family, on the back because we're so good at real estate investing? And I, you know, especially because of the timing, i can't really disagree, but I also am a financial planner and I have access to information to say, okay, now, i've always, when I'm an investment researcher, i want to prove my belief with facts. And so, since I have software where I can look at comparative investments to see how they did over the same time period, i was just curious to say, okay, well, how did things work out in other types of investments in the same period of time? So what I did is I used my software, y charts, and that's a software that can go back and look at different periods of time to see how an investment did. And then I went in and I put in the start date bring 2010. So I wanted to see how things did since 2010. And so I, by using that start date, i was able to put in a value at the beginning of $220,000.

Speaker 2: 9:34

And I used a couple of Vanguard index mutual funds. One of them was the Vanguard 500 index, because let's just compare real estate to stocks, and the other one I used was Vanguard balanced index. So that was a more kind of realistic, like balanced portfolio that an investor may own. And then what I also did was I took an index of Vanguard real estate, because that is like kind of a group of investments that are real estate related in the REIT sector of investing. So they're not, you know, private properties that you buy and sell with a real estate agent. It's a collection of stocks that are similar to real estate And I started all of those in 2010, like I mentioned, then I grew them from an original price of 220,000, because that's my you know sample of how well I did back in the day, if you're like me and you're curious.

Speaker 2: 10:33

Well, how did the other investments do? Well, first of all, the Vanguard 500 index grew in 2010 from $220,000. It's June 22nd today, so I have values through June 20th and the value is 1.058 million. Wow, like stunning investment returns. Past performance does not predict future returns, but in fact your $220,000 would have grown to about double what my investment returns were. And then I look at the two other examples. So if I just looked at kind of a diversified basket of real estate investments, those would have returned an amount of about $618,800. And so that's similar to what my, i think the current value is of that single house not exactly the same and a little bit higher actually. So maybe there was a little bit of advantage to diversification. And then I also took that balance portfolio, so a mix of about 60% stocks and about 40% bonds, and the value of those investments would have been about $642,240. So interesting results. I think they were all great investments And of course we can't say that the next time that you invest in any of those you would have similar results over a 13-year period or so. But quite interesting, all very good.

Speaker 2: 12:03

But my home run house was the fourth best investment in a four investment race Still a great investment as far as I'm concerned. It was very affordable to have that mortgage over time. We were able to refinance. At one point We actually paid extra payments So we were able to pay off the mortgage over time. And of course there may be some and there's some costs that were associated with the home, but we had lower property taxes. We did some home remodels along the way, so those would be kind of added to the costs along the way, which were quite significant. We actually improved our basement from an unfinished basement to finished and did a full remodel of our first floor in the kitchen.

Speaker 2: 12:47

But then you compare it to. You know there are some costs to being an investor as well And one of the primary costs that is not calculated into these results would be if you were paying an investment advisor, then the cost of investing would have come with some additional costs that aren't covered, just like on the real estate side property taxes and maintenance etc. And then there's some tax drag along the way. So if you pay dividends or have income from your investment portfolio which these portfolios would have had, then there would be tax costs if you own these in a taxable investment account. But still, it's intriguing to see, oh my gosh, like it seems.

Speaker 2: 13:29

like you know, all four investments were good and the individual real estate investment which seemed like kind of a home run wasn't necessarily as much of a standout as I myself. So I made that investment, would have assumed I found this in some of the other cases I mentioned where had really strong returns, but also they weren't quite, as you know, what you or my clients had assumed in terms of how good was good. So then I start thinking whether I'm thinking about myself or others. Why do we have these assumptions? And I think that one of the really critical factors is you can't easily buy and sell a house. So you know we bought a house in 2010,.

Speaker 2: 14:15

You know there's no flipping a house, there's no getting out of the market on a day that it seems bad. You sit in that house and you own it because it's a major, major hall to move until you are sure and ready that you're going to move, whether you get transferred, you want a bigger, different home, you want to move to a different neighborhood for schools, whatever real estate if you're the person living in it or if you're managing an individual property, is quite illiquid. It is not something that is easily bought or sold, and so that's a constraint in terms of your ownership. It locks you in over a longer period of time, whereas over that 13 years of ownership of stocks and bonds, you had many, many opportunities many opportunities per day in many cases to make a decision to buy or sell.

Speaker 2: 15:06

And even if you aren't deciding to buy and sell every day, there are certainly moments in time whether it's during a bear market or after the most recent recession, or when there's a presidential election outcome that you don't like, or when there's a pandemic where you could decide oh, i don't want to own that investment, i'll own a different investment or I'd prefer to own cash. So it's easier sometimes to mess up when it comes to investing, because you may have chosen to get out of the market or move to a different investment or be enamored with a more exotic fancy investment, a digital currency or a hot stock during post pandemic times, and so I think that there's a fundamental nature of real estate that you end up owning it longer and then you feel the benefits of long-term investing. That tend to naturally happen across many types of investments. In many cases not saying it's 100% certainty, but that's a really interesting thing to think about is that you have so many opportunities kind of mess things up. In a more liquid investment You also can just say, hey, send me some money because it might be the next place you look after. you look at your bank accounts if you have an investment account, And so there's so many different reasons that can kind of erode the value of an investment whereas you may not harness like if you took a home equity line on your real estate investment that might not be tied to how you think about the performance of an investment. Even if you use that money to improve the house or things like that, you wouldn't necessarily think, oh, i've got to knock down kind of the growth in the investment by $100,000 because the money I had to borrow to maintain the investment or things like that. So I'm just kind of looking under the hood today to give you some guidance and perspective on how a financial planner looks at things. It's not a conversation that's easy to just bring up.

Speaker 2: 17:06

When somebody says I know real estate investing is best, and I don't disagree, like I'm not someone who says you should really be renting, why would you want to own? I have owned multiple properties over time, currently have primary residence as well as a vacation home, and I am all for real estate investing. But I do think it's important for you to understand the dynamics of returns. You need to factor in the carrying costs like insurance, property tax, maintenance etc. And you need to be realistic about understanding both the pros and cons. And I don't want you to knock the value and benefit of investing in more liquid investments like stocks and bonds. In some cases you may need the advice of a financial planner to maintain that control and that long-term perspective and to avoid unnecessary costs like taxes or unnecessary withdrawals or withdrawals that might harm kind of your long-term goals. But when it comes to, for example, retirement, those investment portfolios can be much easier to turn into a stream of income In some cases in real estate, unless you have a significant portfolio of income producing properties.

Speaker 2: 18:22

So I just thought it would be nice to unpack this dynamic of real estate versus investing in stocks and bonds, and I would challenge you to think about what are your assumptions, presumptions, when it comes to investing, that may be more kind of about illiquidity and how that forces you to be an owner for longer, and how does this conversation challenge your assumptions? So I'm planning, the next time this conversation comes up, to ask people hey, would you be willing to listen to my story and use my own real life example And I still am going to be confident and happy to report the timing of the purchase of our last home and the sale But that will come with the asterisk that you should listen to the episode about what I might have given up if I had invested in something else. So with that, for our loyal listeners, we've seen growth in listening and we just want to thank you And, if you are a regular podcast listener, if you'd be willing to like and subscribe. We love to hear what you think And we always welcome your feedback.

Speaker 2: 19:32

Or if there's an episode like this where, personally, i was just dying to get it kind of out and into the air so that I could do my research and also be ready to have this discussion with someone in the future. If you have one of those topics that you just really want us to tackle, please let us know soon, melissa Friedenberg or myself, and email. And then we do have a summer economic update and investment outlook presentation that's coming up in July. It's on July 19th at 11am Eastern, and if you go to our website, pearlplancom slash events, you'll be able to register. So we'd love for you to register and or subscribe to our newsletter so we can be in touch both about our podcast but also our events and other goings on. So, with that, thanks for listening. I hope you're having a great summer and we'll talk to you soon.

Speaker 1: 20:24

You can access our first two seasons of this podcast on our website, at wwwpearlplancom, or on Spotify. If you're interested in learning more about pearl planning, feel free to sign up for our newsletter, also found on our website.