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401k vs Real Estate: Which Is Best?

This is the ultimate debate in personal finance. 401k vs real estate. Who wins? What’s the best way? Why? You will find a lot of proponents and detractors on each side. 

And I can understand why people are so passionate about this. Regardless of which you choose, this is your retirement plan. This is financial freedom for you. It’s important business.

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401k vs real estate

So let’s take a moment to review and compare both options to help you decide which is right for you.

Investing in your 401k

Let’s even broaden our definition. For the purpose of this post, investing in your 401k is synonymous with investing in any tax advantaged traditional retirement accounts. So, the “401k” could actually be a 401k. Or it could be a 403b, 457b, or Individual Retirement Account (IRA).

The point is that you are taking your money and placing it into a tax advantaged space to invest. The name of that space is largely irrelevant. 

Advantages of 401k vs real estate

1. It’s easy

You can very easily automate your 401k investing. All you needed to do is:

  • Create a savings rate (ideally >/= 20% of gross income)
  • Place those savings in your tax advantaged account
  • Select investments for that money according to your asset allocation (ideally low cost, broadly diversified index mutual funds)
  • Do nothing
  • Rebalance back to your selected asset allocation every year

This is a very hands-off way to successfully invest and reach financial freedom.

2. Tax advantages

When you put money into your 401k, it is pre-tax money. Then the money grows tax free based on your investments. Then it is taxed when you withdraw the money in retirement.

This is way better than having the money taxed on the front and the back end like with a taxable investment account. In general, you are also avoiding getting taxed at higher tax brackets while you are working and contributing to the account. Then you take the tax hit when you are presumably in a lower tax bracket in retirement.

This is a big advantage.

This is also the case in most tax advantaged retirement accounts. The notable exception is the Roth IRA (compared to a traditional IRA) in which the money is taxed up front and then grows tax free and can be withdrawn tax free. This option remains open to high income earners via the backdoor Roth IRA.

Further, by investing in these tax advantages accounts, your reduce your taxable income, minimizing your tax burden in the present.

3. It’s protected

By this, I mean that money and savings in your 401k and also tax advantaged accounts are pretty secure from creditors. In other words, your assets are protected.

In comparing 401k vs real estate, a lot of people worry about their exposure to liability. Meaning that if they got sued for something, a car accident or medical malpractice suit, their retirement savings could be at risk.

Investing in your 401k is a good way to protect yourself.

4. The match

This is a big one! Many times, an employer will match contributions to an employee’s 401k. So, as long as the employee i.e. you contributes a certain amount to the 401k, the employer will also contribute a certain amount.

To not take advantage of this is akin to leaving money on the table! It’s free money – take it!

5. It’s safe (when done right)

When invested in a responsible manner using low cost, broadly diversified index funds that approximate the overall market for the long term, investing in a 401k can be very safe.

That’s because over the long term, the overall stock market has always gone up. If you put money in the overall stock market at any point in history and just did nothing and kept it there for 20 years, you would have made a lot of money. 

This is largely what you are doing by investing in broadly diversified index funds. You invest in the ingenuity of humankind over the long term.

When not done responsibly, through active management, individual stock picking, and timing the market, investing in your 401k is just as risky or more risky than anything else. 

Remember, passive investing outperformed active investing 80% of the time!

Now that we’ve covered the major advantages of a 401k, let’s switch gears to real estate…

Advantages of real estate investments vs 401k

1. Higher returns (when done right)

In general, this is true. Real estate offers higher returns compared to investing within a 401k. 

There are many reasons for this which we will touch on more below. But the main key is that, again, investing in real estate must be done responsibly. 

Invest in cash flowing real estate with expected cash-on-cash return of 10% or greater. Do not invest for market appreciation. Consider market appreciation a cherry on top. To invest only for market appreciation is like stock picking. It is speculation, not investment.

2. Many ways to make money

When you invest in real estate, you don’t just make money through cash flow. You also make money from:

  • Equity build up from rental income i.e.tenants paying your mortgage
  • Forced appreciation through decreasing expenses and increasing income
  • Tax advantages
  • Hedging against inflation (rents i.e. your income rises as inflation rises)

You can see how I made money through all of these avenues with my first investment property here.

3. Tax advantages

You’ll see that this advantage is listed both for 401k and real estate. 

With real estate, the tax benefits can be massive. First, every property undergoes depreciation each year. This means that each property creates “paper losses” each year even if the property itself is making money by all of the ways we talked about above. These passive paper losses cover your passive income via rental cash flow.

You can also take advantage of accelerated bonus depreciation currently to increase these paper losses earlier than previously possible.

But, even more, you can obtain real estate professional status (REPS) by working 750 hours or 1 hour more than your other job over a year on your real estate properties. Then, you can use your paper real estate losses to offset your active W2 or 1099 income.

You can also sell a property and buy a bigger one without needing to realize your taxes on the sale using a 1031 exchange.

Again, the tax advantages here are massive!

4. It’s protected

By creating as asset protection structure around your real estate investing, using one of many LLC structures, you protect your investments. This is what I did.

Doing this creates a new, separate company from your personal finances and liability. Thus, if something happens and you get sued due to your real estate business (which is rare), you are protected.

5. Leverage

It’s possible this is the biggest advantage and main reason I am such a fan of real estate investing. And it’s most applicable to those investing in real estate directly.

When you buy a rental real estate property, you can buy it using a mortgage. In this case, you pay a 25% down payment. And the bank or lender gives you a loan for 75% of the rental property.

But, you make money on 100% of the property’s value, including the 25% that you actually paid but also the 75% that you borrowed.

And sure, you make principal and interest payments on the mortgage, but this is much less than the money you are bringing in via rent, equity build up, tax advantages, and inflation hedges. Plus, it’s your tenants paying rent, not you.

Leverage is why real estate is a wealth accelerant.

6. It’s unlimited

This is a nice added bonus.

Your 401k and other tax advantaged accounts are limited in how much money you can put in them.

For instance, in 2022, you can only contribute $20,500 to your 401k account. All physicians need to be saving more than this for retirement.

On the other hand, you can invest as much money as your want into real estate. 

7. No penalties

When you invest in a 401k or other retirement accounts, there is a limit as to when you can withdraw and use your money without a penalty. Take the money out before you reach a certain age and you will be paying taxes and a 10% penalty.

With money made in real estate, you can use it when and however you want to! You don’t have to wait for retirement age. That counts for something.

8. Non efficient market

The stock market is an extremely efficient market. There is very little to no room for investors to take advantage of inefficient for their gain. That’s why I am a strong proponent of index fund investing and why stock picking and timing the market just don’t work.

The real estate market, however, is inefficient. Especially smaller local market. These inefficiencies can be taken advantage of by investors, like me, to create growth and wealth.

We buy from previous owners who did not run a good business model with high expenses and low rents. We change this and run a better business.

So, 401k vs real estate…can you do both?

The good news is that if you are doing either of these, you are winning. Both are a great way to build wealth and constitute a great investment strategy.

Remember, there is a simple formula to reach financial freedom as a doctor. It involves creating a margin between what you make and what you spend. And then investing that margin. You are doing this with both a 401k and real estate.

You can! And you can accomplish this in a bunch of ways.

First, you can maximize your tax advantaged investments accounts and then invest the remainder of your savings into real estate. Or you can contribute enough to receive an employer match in your 401k and invest the rest largely in real estate. This is more or less what I do in my hybrid investing approach.

You can also invest in real estate through your 401k or other tax advantaged accounts. This is a topic for another post, but I am not a huge fan of doing this. The bottom line is that real estate investing is already so tax advantaged, you don’t need those accounts for that purpose. Also, the beauty of cash flow from real estate is that you can use it for whatever you want! You don’t need to wait to withdraw it without a penalty liken your 401k.

Or you can just invest in a REIT or real estate investment trust in your 401k. This provides exposure to real estate although without the tax advantages and generally higher returns.

401k vs real estate…my take

I favor real estate as an investment vehicle for all of the advantages that I listed above. Investing as real estate has truly been a wealth accelerant for Selenid and me as you can see in this net worth update. That’s why we have 3 going on 4 rental properties. But I always hesitate to say it is a better investment. For me it is and it might be for you. But it doesn’t have to be for everyone.

You see, I still invest using a hybrid investing approach as my written personal financial plan calls for. Both Selenid and I max out our 401k to get am employer match. We aggressively pay down debt. And we invest heavily in cash flowing real estate.

401k vs real estate…which is right for you?

In the end, this is such a personal decision. And there are many different ways to reach financial freedom.

However, what I want to reiterate is the importance of goal setting. Create your financial goals. What do you want to achieve? And make these goals BIG! Create your dream life. Then, you need to determine how you will get there. 

Maybe saving and investing in your 401k via index funds will get you there. Perfect! That’s what you need to do. 

Maybe a hybrid approach gets you there. Great!

Or maybe real estate is the main vehicle to drive you there. Fantastic!

Also, you need to make sure that whatever path you choose aligns with your risk tolerance. Again, this will be very personal and there are no wrong answers.

So, take some time with an accountability partner to think about your financial goals and start creating a plan to get there. Educate yourself. The toughest part and most important thing is taking the first step, but you can do it! And I am always here to help!

These posts can help get you going!

What do you think? Do you favor investing in a 401k or real estate? How are you reaching your financial goals? Let me know in the comments below!

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    Jordan Frey MD, a plastic surgeon in Buffalo, NY, is one of the fastest-growing physician finance bloggers in the world. See how he went from financially clueless to increasing his net worth by $1M in 1 year and how you can do the same! Feel free to send Jordan a message at [email protected]

    9 thoughts on “401k vs Real Estate: Which Is Best?”

    1. Interesting discussion. I spent 20+ years in the corporate pharma world stashing away 10% to 30% of our income for more than 25 years. For eleven of those years, I had a 10% 401k company match, and my wife had a 6% match on her 401k. We were easily 401k millionaires by the age of 40 years old. At the age of 43, we decided to also begin investing in rental real estate with a beginning initial investment of approximately $200k in cash savings. I was just beginning to build our long range “dual” investing plan for an early retirement around this point in our careers. The term FIRE wasn’t even an after thought at that time. It became a horse race between our REI’s and our traditional retirement accounts. Eight years later, we individually owned 54 MF rental units, and our REI’s had completely caught up (and surpassed) our now 30+ years of traditional retirement savings. We had invested in our amazing 401k’s for many years, and yet we had doubled our net worth in less than eight years with great rental property investments. We retired early five years ago and haven’t looked back. We are a text book on how either investment type can provide a successful outcome. But with proper leverage and tax advantages, Rental Real Estate will easily win in that horse race every time. We are absolute living proof. Great discussion!

      Reply
    2. So how would you figure in a pension plan on top of your 401k where you’re able to stash over half of your w2’d wages (Possible to contribute significantly more however realistically contributions average half of wages)? We only contribute employee contributions to the 401k since we’ve had the pension over 8 years now. First year for catch up contributions (401k) and we have 4 units w great cash flow and equity but modest appreciation over the past 17 yrs w one property paid off entirely. Greatest amount of equity and appreciation is our o/occ home where we’ve paid additional principal to have it paid in 15 yrs total w 7 yrs remaining. We would like to buy a second home/investment property in a vacation destination where HOAs and management fees are exorbitant. Our intentions are to work another 8 yrs when child graduates high school. Also one last note. Properties are able to be put into pension but require their own accounts for payments etc. Bit much but thought I’d see what someone else might have to say. Thanks in advance for your time.

      Reply
      • Sounds like you are doing fantastic!

        For the pension plan, is this like a cash balance plan you are referring too? If so, those ate a great way to put money away tax deferred and reduce taxes in the present (although will pay upon withdrawal).

        In the end I think it’s all about making sure your investment plan is allowing you to reach your financial goals. From what you have shared, it seems the answer is yes so you are doing great!

        Reply

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