401K or rental portfolio?

14 Replies

Hypothetically, which would you rather have?

A 401K worth $500,000, currently invested in index funds, but easy to convert to other securities or cash. 


10 single family homes worth $1,000,000 with $700k worth of mortgages, 8% yield, and $25,000 per year of cash flow.  Paying down the mortgages at a $20,000 per year clip, but that is increasing yearly as the mortgages mature.  On average, 20 years left on the mortgages.  You self manage the properties.  

Which one do you choose, and what's your investment plan going forward?

There's a few variables missing IMO:

- What return do you expect on the index funds: for example, at 6% a year, compounded & assuming all dividends reinvested, after 20 years you'd have 1.6MM

- What is your time worth in the equation: You invest 0 hours per year with the index funds I assume; VS self management would be a full time job? Is that worth 50K a year? 150K a year? and so on. Is that more/better than you can make with a W2 job with your skillset? (For some people, absolutely you can; for others, the number may need to be quite a bit higher?) 

Alternatively we can assume that it'll cost 75K a year for an employee to manage it, and then add inflation to the wage growth?

- What's the annual rent increase % you want to apply to the income on the properties?

- What's the vacancy allowance you want to apply, what's the maintenance/annual upkeep cost, and so on?

- What tax advantage(s)/disadvantage(s) do you get; the 401K grows 100% tax free (but then you pay taxes upon withdrawal); with the REI, you'll have tax, but also numerous deductions.

Taking a stab at a very simplistic analysis that doesn't account for everything in the above, but why not it's a fun mental exercise :)

- 25K of cashflow accounts for your vacancy rate, maintenance cost, property management (i.e you're paying yourself to manage them before that 25K) and so on; i.e it's free and clear.

- 1MM of property increases in value at 2% annually in appreciation (making a rough guess that at 100K per property you're in a C neighborhood with low appreciation rates? But I may be wrong - happy to get input on this)

- After 20 years, you should see:

Just shy of 1.5MM in real estate value with 2% compounded growth with no mortgage left as it's been paid off now.

An additional 620K of cash from the 25K a year with 2% compounded growth (assume you went with a conservative savings act for it).

That puts you at about 2.1M total value.

With the index fund, starting at 500K balance and 0$ additional contributions, you'd have to get 7.5% average annual compounded return to match that. Without inflation adjustments, and dividend reinvestment enabled, the annual S&P 500 return from 1995 to 2015 has been about 8.6%, so, in this very specific, simplistic, model, it seems to come out better.

Naturally there's way more factors that play in - love to see folks poke holes in this and tell me where I went wrong, and what guesses/assumptions I missed calling out!

it's fine to make your own assumptions, and own decisions about continuing to self manage or not, etc. I intentionally left out a lot of detail so you have the freedom to speculate a bit.  

An interesting observation to me is that the future performance of the real estate portfolio is likely more predictable than the equities (funds) portfolio.  Or at least the real estate gives you less fluctuations.  

Fair points and an interesting mental exercise for sure. One key one I totally left out was how much rent increases would feed into that cash flow; the 25K should see an increase from that, but conservatively if you leave it at the 2% I used includes that, all good.

I'm not sure about future performance predictability; in many areas of the country, folks who bought in say, 2005 or 2006 are still underwater on their homes 10 years later; whereas equity investors who bought at the peak of the market in say, 08 or what not, are ahead today, despite the crash that ensued (assuming they stayed fully invested that is). 

Don't get me wrong; not knocking REI in the slightest (given that I'm a real estate investor that'd be a bit odd ;)); just saying I think there's a place for both (equity AND RE) in the average person's portfolio of investments, AND, I'm interested in getting more detail to understand your statement about predictability / performance!

I'm going to make the assumption that I have left my previous employer and can roll over the 401(k) into a self-directed 401(k) because I've started a small business. Now I've got the freedom to invest in real estate with the 401(k) or debt, or JVs or ...

@Jon Klaus

I would choose having the best of both worlds and investing in both as you should never put your retirement funds in one asset category.

@Mark Nolan

Great point, and totally agreed. Why not have the best of both worlds!

@Jon Klaus

The other point to remember is that with an index fund, you're getting alot of diversification; either S&P 500 or even a total market one, and you buy a major cross section of businesses across sectors, that represent the overall health of the economy.

With RE, even 10 SFH, it lacks that level of diversification.

This can be both good (i.e lets say you bought 10 SFH a few years back in San Francisco; you've got HUGE appreciation and laughing all the way to the bank!) or bad (if you bought those SFH at the peak in a sub-market like so many cities in the US today, you're underwater still).

Not to say you can't achieve diversification with RE as well (i.e buy a REIT); to me, for pure income / cash flow, that's my preferred direction (buy a REIT; I get good diversification, it's property managed, I don't have to worry about maintenance or repairs or whatever else; just a solid cash flow / income stream in the asset class (apartments, shopping malls, whatever else) that I choose).

For appreciation though, I think of RE like picking individual stocks or a business to buy; if you have the time, the skills, and the patience - you can make outsized gains compared to the overall market. (And in RE, you also gain the advantages of more leverage with low downpayments, and, the ability to increase equity (i.e making improvements/fixers/etc.) that you don't get buying an individual stock...)

My $0.02 at least :)

I use my 401k to buy my investment properties. Every rental I purchased I borrow from my 401k to put down on my rentals.  Then I pay myself back plus about 4.5% interest. (Going rate of my last purchase)

Maybe not all 401k plans are not setup to borrow from but the company I work for has it.

My last purchase I borrowed $40,000 to purchase a $94,000 town home.  I used $20,000 to buy the property and pocketed the other $20,000+- for my hard work.  The rent pays for my payback payments of my 401k and I had the $20k in advance.

 Some my say never borrow from your retirement but I feels it's a good asset transfer. 

I would choose real estate.  Real Estate is tangible and has a insurance policy.


@Jon Klaus

I would look into private lending/notes/syndications with my 401K funds before purchasing real estate. You would have to get a non-recourse loan to borrow in the name of you 401K which would mean higher downpayment (30-40%), higher rates, balloon in 10-20 years, you would still have to pay tax on the financed percentage but you do not get the to use depreciation, interest deductions, etc. I would much rather prefer to borrow from my 401K to purchase property outside of the 401K. You can diversify between several notes to minimize the risk of any one not performing. I hope you share with us what you decide and why? It is a nice problem to have :)

Originally posted by @Jon Klaus :

Hypothetically, which would you rather have?

A 401K worth $500,000, currently invested in index funds, but easy to convert to other securities or cash. 


10 single family homes worth $1,000,000 with $700k worth of mortgages, 8% yield, and $25,000 per year of cash flow.  Paying down the mortgages at a $20,000 per year clip, but that is increasing yearly as the mortgages mature.  On average, 20 years left on the mortgages.  You self manage the properties.  

Which one do you choose, and what's your investment plan going forward?

Great topic!  

I'd go with the real estate.  For starters, I'm young and would like to enjoy some $ before I get to my 60's, so 401k generally isn't all that exciting to me.  Even if I could freely withdraw $ or take income from a 401k, the real estate still seems like the better choice.

REI: 4% appreciation, 3% rent increase (reasonable to conservative)
401k: 7% appreciation, 3% income (not reinvested because I'm not assuming reinvested REI income) (reasonable to aggressive)

At the end of 20 years, you've either got $2.1M in free and clear real estate that is generating $160K+ income per year (based on your 8% yield) or you've got a 401k balance of around $1.8M throwing off about $55K in dividends.  Throw in the tax benefits of depreciation and the higher income that you get in your pocket from real estate and I'm not seeing any reason to take the 401k over real estate.

One of my favorite quotes from Warren Buffet: "Wide diversification is only required when investors do not understand what they are doing."

A real story. 

43 yrs old

Paid for house


$95,000 in Ira and/or 401k plans

In 2002 I bought a cheap, very cheap distressed house. Now, 13 years later because of leverage and renters paying for my rentals:

$20,000 in iras and/or 401k plans and $1.5M equity in rental properties. And in a few more years, when the renters pay off my current loans, $3M in rental property with $40monthly gross rents.

Buy and hold rentals are the real deal. 

just think how nice it would be if half of the real estate discussed were tax free income for life in a Roth IRA/401k.

Not sure much beats producing real estate assets in a Roth.  My best find in the real estate world. 

u must have taken a peak at my quicken file! 

sell the assets in the 401k and buy 15 SFH with more cash flow and/or less debt. Do it all in the 401k or IRA AND LOOK TO CONVERT TO TAX FREE. 😄

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