401k vs. Rentals -- What is the Better Investment?

There is no concrete answer to this question. Like with so many things in life, it depends. This article is going to compare/contrast the two. It will also provide some points to consider before making your investment choice.

  • Tuesday, December 27, 2016

  General   Tips   

There is no concrete answer to this question. Like with so many things in life, it depends. This article is going to compare/contrast the two. It will also provide some points to consider before making your investment choice. Let's first consider the 401k.

401k - How it Works

You contribute to your 401k using pre-taxed dollars. Your contribution is then matched by your employer up to a certain limit. The amount varies, but it is in the range of 3-6% of your annual income.

Don't get too excited about being able to contribute pre-taxed dollars. The IRS gets their cut, once you retire.

It is important to note that this is a retirement plan and not a savings account. It works like this because once you put your money in, it's not coming out (in whole) until retirement. Early withdraw of your funds comes with huge tax penalties.

Is this the right investment for me? Ask yourself a few key questions:

  • What percentage of my contribution will my employer match?
  • How many years do I have left for my retirement?
  • Do I need access to these funds in the near future?
  • Do I know of better investment opportunities?

Keep these answers in mind as we touch on investing in rental properties.

Rental properties

Rentals are for people who want more of a “hands-on approach” to their investment. Instead of a passive investment, you will be running a small business. Here are some things you will be responsible for as a landlord:

  • Purchasing an investment property
  • Finding tenants
  • Collecting rent
  • Maintenance on the house

The work involved can often be more than people are “cut-out” for. That is, unless, you find a qualified property management company.

Similar to a 401k, properties are typically a long-term investment. At first, most of your rental income will be going towards a mortgage, but by retirement, you will be able to pocket a larger chunk.

Your money will also get “tied-up” in real estate for the first years. This is because selling quickly can often result in a net loss. A loss can occur because the closing and selling cost can often equal more than the increase in value. Here are some questions to consider before investing in rental properties:

  • Do I understand the market?
  • Do I have the technical knowledge to invest successfully?
  • Do I fully understand the risk/reward involved?

How to make the right decision?

You need to spend the time to calculate your estimated earnings by retirement. Which do you think is more profitable? Understand the risk involved. Even your 401k is not guaranteed. Understand the tax laws. Real estate has a lot of tax advantages you may not have thought of.

The answer

Here is a simplified formula to help get the gears turning. Use the equation for both your 401k and your rental properties then compare the two.

(Total estimated profit x percentage risk of loss) minus taxes= total profit

One last note

If your 401k profit and real estate profit are similar, do a final consideration of time spent. Do you want to spend your retirement taking care of rental properties? If not, hire a qualified property manager and add in the costs to your equation.

VerticalRent is a perfect tool for a "do-it-yourself landlord." It provides background checks and offers assistance with leases, collecting rent and more!


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