The Power of Leverage.
I am constantly asked to comment on the age-old comparison: stock market vs. real estate. Historical evidence supports the fact that there is absolutely money to be made by squirreling it away into stocks endorsed by Warren Buffet!
However, I want to suggest an analysis that conveys the importance of the power of leverage in investment. Leverage is a powerful tool that intimidates many people, yet when applied properly can yield a substantially higher amount of money than stock market investments can even begin to yield.
Let us start with what we know. We know that over the last 20 years, the stock market has produced about 7% annual return. So, let’s say you had $160,000 and invested every penny into what Warren Buffet suggests. This includes 401(k), IRA, and 529 plans. Now let’s say you hold on to your portfolio for 15 years. At the end of that 15-year period—assuming you averaged 7% annual returns—your portfolio will be worth $441,445. That sounds great! Right?
Now, I am not saying that $441,445 is bad. Butttt…we can do better by investing in and leveraging real estate. Let’s take that exact same $160,000 and leverage it to buy a $450,000 property. We put 35% down because we are putting it on a 15-year note. If nothing else changes, at the end of 15 years, you will own an asset that is worth $450,000 (in Colorado?) Already that is better than the stock market. However, we accounted for a 7% annual return with the stock market. On our real estate investment, let’s assume a conservative 3% appreciation year-over-year. Plus, we can also add the $35,000 rental income you created for the rest of your life. If you combine the 3% appreciation and the $35,000 income, now you are looking at an asset value of $705,000! Simply by leveraging$290,000 over 15 years, you were able to gain $263,555 more than the stock market alone.
This is a very simple and very conservative analysis comparing the two investments. It doesn’t even factor in risk, and I have a theory about risk that will change the way you look at risk forever. Stay tuned!