Out of College, Should I Invest in Real Estate or Retirement Accounts?

Out of College, Should I Invest in Real Estate or Retirement Accounts?

5 min read
G. Brian Davis

G. Brian Davis is a landlord, personal finance expert, and financial independence retire early (FIRE) enthusiast, whose mission is to help everyday people create enough rental income to cover their living expenses.

Experience
Through his company at SparkRental.com, he offers free rental tools such as a rental income calculator, free landlord software (including a free online rental application and tenant screening), and free masterclasses on rental investing and passive income.

He’s been obsessed with early retirement since the early 2000s (before it was “a thing”).

Besides owning dozens of properties over nearly two decades, Brian has written as a real estate and personal finance expert for publishers including Money Crashers, RETipster, Think Save Retire, 1500 Days, Lending Home, Coach Carson, and countless others.

Here’s to financial independence with real estate!

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Recent college grad? Congratulations! Now comes the hard part: making a living.

Let’s say for the sake of argument you found an entry-level 9-5 job in a field that interests you. The pay isn’t great, but you’re gaining experience and building a resume.

Despite not bringing home boatloads of bacon, you know how important investing is, so you set aside 15-20% of your paycheck for investments. But where should you invest? They didn’t teach that in college.

What makes a better investment, retirement accounts or real estate?

Reasons to Invest in Retirement Accounts

Unless you die young in a tragic noodling accident, you’ll probably want to retire one day. Uncle Sam doesn’t want you living in an alley when you do, so the IRS offers some great incentives to encourage retirement savings.

In 2016, younger adults can invest up to $5,500 in their IRA or related funds like Roth IRAs (for deferred savings on taxes) and SEP-IRAs (for self-employed people). That income is tax-free, deducted from your taxable income (unless you choose the Roth option, in which case your later returns and withdrawals are tax-free instead).

But IRAs aren’t the only option available. You can also use a 401K or related funds, which have a higher contribution limit of $18,000. If you’re self-employed, it’s harder to set up your own 401K than it is a SEP-IRA, so 401Ks are usually a perk for full-time employees. There are Roth options available for 401Ks as well, if you want to pay taxes now and save on the returns later.

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Related: How to Use Real Estate to Retire MUCH More Comfortably Than Your 401K Would Allow

If you’re really excited about retirement investing, you can invest in both a 401K and an IRA for a combined maximum of $23,500. Above a certain income level, that option phases out, so talk to your accountant if you’re that gung-ho.

Assuming you go the traditional route, rather than Roth, you’re effectively earning an instant return on all money you invest tax-free — saving the 20-40% you would have otherwise lost to taxes.

Best of all, many employers offer matching contributions. They’ll match whatever you contribute to your account up to a percentage of your income. Read: free money.

Reasons to Invest in Real Estate

There are entire books written on this subject. Volumes. Best-selling series, even.

But we’ll do a 30-second lightning-round review of the biggies:

  1. Passive income from rental properties. Money comes in every month, but you didn’t have to work (much) to earn it. It’s ongoing, residual income.
  2. Higher net worth. As you build equity in properties, both from appreciation and lower mortgage balances, your net worth bulges and expands. Equity gains are also largely passive, with little work required on your part.
  3. Opportunities for quick profits. I don’t need to elaborate — you’ve all seen Flip this House or some variation thereof. It’s possible (but far from guaranteed) to make a quick buck on property flips.
  4. Tax advantages. Thought tax advantages were only for retirement accounts? Think again. You can deduct every conceivable expense, plus a few paper expenses like depreciation. Travel, entertainment, and home office expenses? Also deductible.
  5. Leverage-ability. You can use other people’s money and other people’s time to build your own income and assets.

There are many other reasons to invest in real estate, like enforced savings, but to list them would risk this article metastasizing into a tome.

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Setting Goals

“So you’re telling me they’re both good? What use is that advice when I’m trying to make a decision here?” Glad you asked.

Everyone has their own financial and life goals, and they’re all different. One person might be best off avoiding real estate altogether and maxing out their retirement accounts. Another might become the next celebrity real estate mogul, cigar and mustache included free of charge.

Before you do anything, think long and hard about your long-term financial goals. This inevitably means thinking about your career path as well: Do you intend to work your entire career in a relatively stable sector, like government or healthcare? Or will you ride the winds of fate to see where they blow?

People with long-term careers in stable industries with good benefits usually think more in terms of building a large nest egg. They may not feel compelled to branch into alternative income streams.

Others, like myself, crave financial independence: enough income from investments that you’re no longer dependent on a job to pay your bills.

Related: How to Go From Zero to $8k/Month in Retirement Income (With No Remaining Debt)

What are your goals? Do you want to go travel the world? Are you tolerant of the risks and labors of being a landlord? Are you interested in putting in the work to become an expert in a real estate niche? Or do you enjoy the stability of working in one career and gradually building a nest egg?

There are no wrong answers, only personal goals.

Doing It All

Who says you can’t have your cake and eat it too?

First of all, you can leverage your retirement accounts in your real estate investing. You can “borrow” money from your 401K, at far lower cost than traditional loans. Or you can invest in real estate as your investment of choice within the retirement account!

To do so, you need a self-directed IRA or 401K with a custodian that allows it. But instead of investing in a specific stock or mutual fund, you can invest in a property. The proceeds still need to be reinvested back in the retirement account, though.

Or go the more conventional route and just put money in both retirement accounts and real estate investments.

Most real estate investors start investing on the side while working a full-time “normal” job. You can learn the ropes of real estate investing during your off hours, and it’s not so hard to create more time for your investing work while working full-time. The more you learn, the lower the risks become in real estate investing.

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So Wait, What Should I Do With My Money?

Unequivocally, you should always, always take advantage of employer matching contributions. If your employer will match your 401K contributions up to 5% of your income, invest at least 5% of your income into the 401K. To do otherwise is to turn down a free 5% bonus from your employer.

If you’re reading BiggerPockets, you probably aren’t content with gradually building a nest egg, working into your silver years then flipping the retirement switch.

So find a niche that meets your financial goals! For me, it’s long-term rental properties. I want regular, semi-passive income. Perhaps you like the fast-paced action of flipping. Or maybe you want a portfolio of vacation rentals around the world. Some people prefer the distance of note investments and hard money lending.

Begin by attending local real estate investing association meetings. Meet other investors. Find a mentor and senior partner. Do your first few deals under their guidance, and if you still like them, renegotiate an equal partnership. If not, branch off.

None of this is to say that you should ignore your retirement accounts. Take advantage of the tax benefits. Diversify your equity investments across sectors and regions. Capitalize on compound interest.

If you invested $100/month starting in your 20s and it earned 1%/month (12% per annum) for 40 years, you’d have $1.17 million. Your procrastinating friend who waited until she turned 50? If she invested $1,000/month at the same return, in 10 years, she’d only have $230,000. You’re investing a tenth what she is, but you started earlier, so you’re a millionaire. Compound interest is a beautiful thing.

Ultimately, put your money in what’s most exciting for you, without crossing into the territory of uncomfortable risk. No matter how you invest, find people skilled in that sector or niche, and badger them until they agree to teach you what they know. Learn from the best, and you’ll become the best.

Just starting out? Share your thoughts, and get some feedback from the wily veterans. Or maybe you’re older and wiser, and can regale us with tales of your misspent youth! No judgment from me, I did all kinds of stupid things in my 20s (not all financial, either).

Leave your comments below!