Sam Swenson, CFA, CPA, The Motley Fool Published 4:00 a.m. MT Aug. 10, 2020
Its a great time to check up on your retirement plan. This is how you do it. Buzz60
FIRE (Financial Independence, Retire Early), a flourishing lifestyle movement, has crept its way into mainstream culture throughout the past decade. As we've seen the pandemic spark a renewed push for people to create more autonomy in their lives, there is continued debate about the most sensible way to invest if FIRE is your goal. Real estate proponents advocate for potentially robust monthly cash flow, price appreciation, and tax advantages, whereas index fund adherents cite minimal expenses, a lack of constant oversight, and efficient trading as reasons to invest. In reality, there are benefits to both strategies, which might lead you to consider a hybrid approach.
You'll hear FIRE proponents across the internet lauding the benefits of real estate investing, and in the right circumstances, you should listen. The benefits of direct investing in real estate are well documented: you'll receive stable monthly cash flow in the form of rent payments and will benefit from potential price appreciation of the property if you hold it long enough. In most cases you will need to take out a mortgage on the home and as the landlord, you are now responsible for maintenance, lock-outs, and taxes. The idea is to become "cash-flow positive"; that is, your monthly rent receipt on the property exceeds your monthly obligations to lenders and government entities.
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The true benefits of direct real estate investing accrue once you've built a portfolio of properties that can provide significant positive monthly cash flow as a reliable source of income. This cash flow can either be reinvested into other properties, spent on regular obligations, or invested in other financial instruments. Additionally, you will, in all likelihood, benefit from price appreciation on the properties over time, allowing you to greatly increase your on-paper net worth. Once you've paid off the mortgages, you'll only be required to pay your taxes and keep the properties in working condition from there, your path to FIRE will be significantly shortened.
(Photo: Getty Images)
There are many risks, however, with using real estate alone as a path to financial freedom. First, many real estate investors would agree that property management is a job in itself the process of finding tenants who are able to pay rent every month, especially during a global health crisis, is understandably quite challenging. If the time commitment is too much, you always have the option of investing indirectly in real estate with REITs (Real Estate Investment Trusts). Second, if you own a property in a high cost of living area, down payments can run in to the several-hundred-thousand-dollar range, making owning several properties or even one property a privilege reserved for only the very wealthy.
In addition, real estate can suffer from illiquidity issues in other words, you may not be able to sell your rental when you want, which of course will be when you need the cash most. It's important to distinguish that the process of buying an investment property is not the same as buying a primary residence the initial decision-making process, as well as the end goals, are significantly different.
Index funds are investment vehicles designed to provide diversified exposure to world stock indices, specific sectors, or focused themes. Some generate periodic dividends (usually quarterly), and most broad market indices have demonstrated measured but meaningful growth over the past century. The subtle beauty of index fund investing lies in its passive nature once you've selected a few funds that match your risk tolerance and asset allocation needs, there really isn't much more to it. Your focus can move away from investing and on to life's more important concerns: your career, your family, and whatever else to which you want to dedicate precious time.
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A primary difference between index funds and real estate is rooted in monthly cash flow. Investing in real estate has the potential to generate more stable cash flow on average. Speaking literally, this refers to more cash being paid directly to your bank account every month. The primary gains that accumulate to index fund investors are in the form of price appreciation, which comes as result of the market slowly churning up over time. Index fund investors often enjoy quick payouts from cash dividend payments, but they tend to be relatively small in nature when compared to rent receipts.
Many of the discussions in personal finance are focused on choices around investment vehicles and the relative merits of each. In the pursuit of building a complete portfolio that captures the maximum potential benefits available while also addressing identifiable risks, it seems prudent that both index funds and real estate should be included. This tends to become more achievable if you live in an area with low cost of living and have the time to manage real property while allowing your index investments to grow simultaneously. Regardless of where you live, a reasonable capital allocation that includes a variety of investments addressing different needs will supercharge your path to financial independence.
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