House or Index Fund: Which Is Better?

new-1158139_640By Gabby Revel

Long-term passive investments are secure places to keep your money and there are several varieties. Two common passive investments are investing in a home and index funds. Which one is better for your money?

The Investment Vehicles

Real estate investment works like this. You buy a home at a low price. Over time, you maintain or improve it. As property values go up and the property is improved, the value of the home goes up. At a later date, you sell the home and reap the profit off the original investment minus improvements and taxes.

An index fund is a type of mutual fund that tracks the performance of a particular stock index, such as the S&P 500. As the overall index goes up or down, the value of the fund changes. The advantage of these funds is that the stocks they hold don’t change much at all. This means it’s much cheaper to manage the fund, which saves the investors a lot of money in the long run.

Which is Better?

Short answer: the index fund. Here’s why.

Index funds run on a principle of “if you can’t beat them, join them.” Over time, index funds have been found to gain about 10-11% in value. Few investment vehicles have such a consistent rate of return. The market still has to be timed so you sell when it’s up, but the swells are much larger. As long as you don’t sell when the market is down, you’ll make money.

A house is a much riskier investment. The lessons of the 2008 financial crisis tell us reams of information about the risks of sinking all your investment money into a home. Unlike an index fund which relies on the actions of an entire market, an individual home price can fluctuate a lot depending on demand, the surrounding home values, what’s popular in home accessories at the time of sale, and so on.

Plus, unlike a mutual fund, a home decays over time. Costs have to go into its upkeep and taxes have to be paid yearly. This is why many people in real estate try to “flip” houses quickly. They’re trying to boost up the price of the house high enough for it to profitably sell before taxes, mortgage, and improvement costs eat through their investment.

But what if you’re not into flipping and just holding on to your house for the long-term to sell at retirement? You still run into the same problems. Yes, you could get all your money back and then some if you can sell at a higher price than what you bought it at 30 years ago. But the costs of keeping the house and property maintained and the cost of taxes slowly eat into those profits. And, you’re also investing thirty years into the maturity of the house.  These costs can be very hard to predict, unlike the costs of an index fund. By the end of it, most homes are just a hedge against inflation unless you get lucky.

You do get one advantage. A place to call your own until you sell.

If you’re looking for a safe place to put your money, the choice is clear. Go with the index fund. They’re proven performers over time and it’s an easy investment vehicle to use, even if they only give average returns.

Gabby Revel is a freelance writer specializing in personal finance, business and family-related topics. A former New Yorker, Gabby now lives in rural Montana with her husband and son.

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1 Comment

  • I would say that real estate investing does not work anything like you described.

    What you described is buying a home.

    Buying a home is the furthest thing from investing. It’s kind of like buying a car, except a house usually holds it’s value better. Some cars appreciate in value while more often than not, homes appreciate (but not always).

    Real estate investing is buying property that provides a known return yearly. In stocks that is called dividends, in real estate its called rent.

    Speculation is buying something and Hoping it goes up in value instead of down. It’s just a guess really since you can’t control what happens in the market. You can speculate in stocks, real estate, tulip bulbs, or anything else.

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