Would you invest in 401k instead of invest in real estate?

146 Replies

Assuming you have a corporate job with employer matching 401k, would you save money for down payment for real estate investment or would you invest in 401k?

I understand this question can be answered differently depending on the situation. If a person wants to have a stable steady long term retirement plan for 30-40 yrs down the road, maybe maxing out 401k is a better choice. But if a person seeks early retirement and financial freedom, maybe saving up for down payment for REI might be a better decision.

The latter choice is probably appealing to most of you, since after all this is REI forum, but I would like to hear your input given the situation.

Its about diversification. Spread the investments around. 401Ks are great pre-tax investments especially with an employer match. Free money! 

Here is the easy answer.

If your employer matches a percentage (typically its up to 3%) then invest that much into your 401k because it's free money. However, if your employer doesn't match then it's up to you. 

Personally in this current market in my opinion the stock market is way overpriced and we are due for a major correction in the near future.

And who actually saves up money for a down payment? Just open up some lines of credit at 0% max out your lines and boom there is your down payment. 

Michael

I think a lot depends on your personal finances.  When I first started working, I read all of those trendy personal finance blogs and books and so max'd out my (and my spouse's)  401k.

Seven years later, I wish I hadn't and here's why:

1. Access to funds.   Having all of my money tied up in a 401k really limits my options on both what to invest in and when to use the money.  If I withdrew it all in one hunk I would jump two tax brackets (at least) and owe a 10% penalty.  And rule 72t does not let me get at the money quick enough because I'm still pretty young.

2. I make a lot of money and live modestly.  Okay, not that modestly, but still a lot less than we earn.  A lot of the saving "rules" don't necessarily make a lot of sense for high income earners who live modestly.  I could easily invest enough in a 401k to get the match and have plenty of cash leftover to invest elsewhere.  Saving 10% of my salary in a 401k is a lot more than the average Joe.  Those rules of how much to save are just guidelines.  Just as important, maybe even more important, is how much you SPEND.  Your expenditures are what drive how much cashflow you need to retire.  Whether it be from income producing real estate or 401k withdrawals.

4. 401ks don't produce immediate income.  Most 401k investments are stock.  Yeah, they generally grow in value, but you can only realize it when you sell and withdraw the money.  My rental properties earn income that I can realize TODAY, even with the principal tied up in the house (or downpayment or whatever).

In general, you should never give up free money, which is what a matching 401k contribution is.  Let's say they match you dollar for dollar, that's an immediate 50% return on your money.  Its hard to beat that.

That said, I do not invest in real estate for the ROI. I'm doing it for the cashflow. My ROI could be zero and I would still invest if the investment hit my cashflow target. Why? Because at the end of the day I am looking to replace my 9-5 income so I can quit, I don't give a flip what my ROI looks like as long as the money keeps flowing in.

If I had to do it over, I would advise young me to contribute enough to get the company match, and maybe even enough so that I could retire if I worked for 30 years.  What can I say, I am a conservative risk averse person.  I would invest the rest in income producing real estate because, at the end of the day, it's all about cashflow.  

If its a choice between getting the match or doing real estate, that's a tough one.  I think I would pursue using Other People's Money (OPM) to do real estate before I would give up the company match, but that's just me (and like I said, I'm a bit conservative).  Usually you can borrow against your 401k (which I have) so you could get the match and then borrow it to invest later on.

Updated almost 2 years ago

Edit: Actually, its an immediate 100% increase.

Originally posted by @Amy E. :

1. Access to funds.   Having all of my money tied up in a 401k really limits my options on both what to invest in and when to use the money.  If I withdrew it all in one hunk I would jump two tax brackets (at least) and owe a 10% penalty.  And rule 72t does not let me get at the money quick enough because I'm still pretty young.

This is my main concern. All my money will be tied in 401k and I won't have access to it until i am 60+

2. I make a lot of money and live modestly.  Okay, not that modestly, but still a lot less than we earn.  A lot of the saving "rules" don't necessarily make a lot of sense for high income earners who live modestly.  I could easily invest enough in a 401k to get the match and have plenty of cash leftover to invest elsewhere.  Saving 10% of my salary in a 401k is a lot more than the average Joe.  Those rules of how much to save are just guidelines.  Just as important, maybe even more important, is how much you SPEND.  Your expenditures are what drive how much cashflow you need to retire.  Whether it be from income producing real estate or 401k withdrawals.

Yup, that's what my wife and I are doing. Minimizing the expenses while potentially increase the revenue. I think minimizing expenses is way easier than increasing the revenue.. for me at least... for now

4. 401ks don't produce immediate income.  Most 401k investments are stock.  Yeah, they generally grow in value, but you can only realize it when you sell and withdraw the money.  My rental properties earn income that I can realize TODAY, even with the principal tied up in the house (or downpayment or whatever).

BINGO!

In general, you should never give up free money, which is what a matching 401k contribution is.  Let's say they match you dollar for dollar, that's an immediate 50% return on your money.  Its hard to beat that.

That said, I do not invest in real estate for the ROI. I'm doing it for the cashflow. My ROI could be zero and I would still invest if the investment hit my cashflow target. Why? Because at the end of the day I am looking to replace my 9-5 income so I can quit, I don't give a flip what my ROI looks like as long as the money keeps flowing in.

I agree. Maxing out 401k is very tempting since it's free money. Yet I am leaning toward having enough properties to create my financial freedom, which means I need to focus on cashflow. Fantastic advice, @Amy. 

If its a choice between getting the match or doing real estate, that's a tough one. I think I would pursue using Other People's Money (OPM) to do real estate before I would give up the company match, but that's just me (and like I said, I'm a bit conservative). Usually you can borrow against your 401k (which I have) so you could get the match and then borrow it to invest later on.


Yup essentially, this is what I am asking. If employer matches your 401k, that is a deal I am not sure I can pass on, yet I truly believe using REI as a vehicle, anyone can create their financial freedom. I will look into borrow against 401k option, but from what I understand you have to pay double the fee with this option.

Thanks for the advice, @Amy E

Diversify. I prefer real estate because it has tax advantages and is "real" and "tangible". I have a pension and a tax deferred option I can borrow against. I wish I had done a Roth while I could first, then real estate.

I use leverage and someone else is paying off my debt on an appreciating asset while I depreciate it on my taxes. Just wish I had started earlier. Now thinking how I may be able to show my kids these benefits before they are my age.

Fantastic question. I've been wondering the same thing. My company doesn't match and only allows me to put 2% into 401k. What a joke. Investing in real estate just seems like the right thing to do.

@Roy C.

Debating between funding an employer sponsored 401k and investing in real estate is a quandry. I'll agree with most here that I'd probably take advantage of of the employer match at the very least if such is offered. You should also keep in mind that you are getting a match from the IRS (and maybe your state) to the tune of your marginal tax rate. If you are in the 25% tax bracket that means you are choosing between putting $10K in your 401k or $7,500 in your personal investment fund. It takes a pretty superior ROI in real estate to make up for that difference. Absolutely it can be done, but something to be aware of.

If you are self employed, you can have the best of both worlds and establish your own Solo 401k into which you can contribute on a tax-deferred basis AND invest in real estate.  Of course, the funds are still locked up until age 59 1/2, but in exchange for the extra amount you can build into that savings pot through the benefits of tax deferral, it can be well worth it.

Ultimately, every investor should do both - save in a tax-sheltered retirement plan and invest in real estate with after-tax dollars.  How you get there and when is really the question.

@Roy C.

My employer is matching 100% up to 4% of my income in a 401k plan. and I haven't yet invest a penny in it. 

All of my colleague think i am sort of retarded, but I think about it as simple as this: when you invest in a 401k. you automatically tell yourself that you will retire at the age of 65+. I want to have the option to retire when i'm 30 to 35 , so 401k will not work for me. The answer to your question is: it depends on your goal

Instead of diversification, i focus on "the one thing". the thing i love the most and do the best at. That one thing is real estate.

@Huy N. yeah but you are leaving a free 4% on the table, which can be quite a lot of money.

For the reasons already stated, I put in what my employer will match me and not a penny more. I'd rather have control over my funds and being a finance guy, I believe that I can earn a better return (normalized over 30 years) than my 401k manager (who I have never met and will never meet by the way. Does that scare anyone?)

But at the same time, you can't leave money on the table. You need to take advantage of an employer match, no question about it.

I don't really care about the tax deferred benefit mainly because I know I'll be in a higher tax bracket when I retire than I am in currently :)

Originally posted by @Huy N. :

@Roy C.

My employer is matching 100% up to 4% of my income in a 401k plan. and I haven't yet invest a penny in it. 

All of my colleague think i am sort of retarded, but I think about it as simple as this: when you invest in a 401k. you automatically tell yourself that you will retire at the age of 65+. I want to have the option to retire when i'm 30 to 35 , so 401k will not work for me. The answer to your question is: it depends on your goal

Instead of diversification, i focus on "the one thing". the thing i love the most and do the best at. That one thing is real estate.

 You know if you told me that you are not maximizing in 401k six months ago, I probably would agree with your co-workers. But ever since I took the blue pill, I can see the merit of not investing in 401k. And you are absolutely right. By putting money into 401k, you are mentally preparing yourself to retire at 65+, which is not my intention. 

I like that you are focusing on the one thing. My one thing has been REI also. I have been reading, meditating, and dreaming about REI. Thanks, Huy N.

@Roy C. @Huy N.

I disagree that if you invest in a 401k you are mentally preparing yourself to retire at 65. You are just telling yourself that you won't be able to access those funds until you are 65. That doesn't mean you have to retire at 65.

That thought process leads to leaving an employer match on the table, which I think is nuts. You need to take advantage of all financial tools available to you, and again this one is free money. I agree I wouldn't max it out, but at least get the match.

If putting 4% into a 401k cripples your investment strategy, you are doing something wrong.

One thing I haven't seen mentioned is vesting timelines. If your goal is to retire in a year but it takes five years to vest, then don't contribute to the 401k.

Originally posted by @Brandon Hall :

Roy C. Huy Nguyen

You are just telling yourself that you won't be able to access those funds until you are 65. 

That thought process leads to leaving an employer match on the table, which I think is nuts. You need to take advantage of all financial tools available to you, and again this one is free money. I agree I wouldn't max it out, but at least get the match.

If putting 4% into a 401k cripples your investment strategy, you are doing something wrong.

Thanks, Brandon. I highly value your input. And just millions people out there with 401k, I just don't like the idea of not being able to get access to funds until 65. You are right, if putting small fraction of % into 401k cripples the investment strategy, then I'm doing something wrong. With my budget, after maxing out the match and other retirement plans, I do have enough room for REI. However, what I plan to do is to optimize cashflowing REI to speed up early retirement plan by 20-30 yrs. With that goal in my mind, I am just not sure if investing in 401k is a smart move even if it means free money in a long run.

It depends how long you are planning to stay with the company really. My employer matches up to 6% and also payed out an extra 1.5% percent last year for those who did and did not contribute based in company profits. I'm not looking to stay with this employer much longer in which I will have the chance to cash it out with a 10% penalty and some taxes. Even though I will lose some of the money I have put it I look at it as what I can do with the money now. Matching 6 percent and an extra 1.5 percent just because is an excellent thing for me to take advantage of but would only realize the immediate potential as I will be leaving within the next year or so.

Originally posted by @Brandon Hall :

I don't really care about the tax deferred benefit mainly because I know I'll be in a higher tax bracket when I retire than I am in currently :)

what do you think about the Roth 401k? I currently max that out, partly because i think i will be in a higher tax bracket when i withdraw.

to those who are mentally telling themselves that contributions are mentally triggering a retirement at 65, god help you if you can't control your mind better than that.

Roy, IMO, take the free money! No guarantee that REI will be a money maker for you and then you will feel really bad that you gave up your employers match. I would scrimp and save and come up with $$ for a down payment on RE after you maxed out the 401k.

 Plus, if it's a choice between a 401k match and a down payment you might be underestimating the costs/risks of a RE investment.  You will need adequate reserves in order to be a successful landlord.  Trust me, things will break, tenants will leave unexpectedly, taxes will go up, etc.

I understand the mindset of "telling yourself your going to work till 65" if you match your companies 401k, however am I wrong in thinking that even if you cash it out early and pay the 10% penalty and taxes, even not taking compound interest into consideration you are still well ahead? Half of the money was "free" to begin with and even at the highest tax bracket WITH the 10% penalty you will still get more than 50% back.  Add that to compound interest not only on your money, but the "free" money that was in the account for the time you were with the company and it seems like a no brainer...  

Is my thinking off on this?

YOU CAN TAKE THE MONEY OUT OF YOUR 401K BEFORE 65!

BP is the best resource on earth for real estate investing.  But we don't know much about 401(k)s....

You can leave work today and access your 401k using the 72(t) rule.  In short, you can take the money today, without penalty, as long as you promise to take the money in a certain way. 

If that doesn't work for you, you can roll that money into a Roth (which requires you to stop deferring some taxes) and you gain access to a bunch of that money.  

Or - worst case scenario, you can pay the 10% penalty for early withdrawal.  This is real money, but should not be a barrier to the 100% match you would be getting from your plan.

You can also access these plans at 59.5 (not 65).

And please understand the money vs cashflow distinction beyond the talking points.  Ultimately, we all need cashflow, but converting a pile of money (such as in a 401k) into a stream of cashflow is extremely easy.  Real estate can do both, and increase your value while also giving you a monthly check, but so can a lot of stocks.  And some popular RE gurus do not get that money is money...

Investing is always better than not investing.  And real estate is an awesome investment.  But the the correct decision for you always depends on your situation.

Happy Hunting!

(I'm not a tax person, lawyer, CPA, CFP, MBA, RN, etc. so please don't take this as professional advice.  just my two cents)

One thing to consider if you are not going to use the 401k money in retirement is that your heirs miss out on the step up in basis. I've seen a couple situations where the children borrow with balloon payments expecting their inheritance to be X, and when it turns out to be X-taxes things get bad.

At a minimum, at least contribute to what your employer will match, and consider it as your employer investing in your real estate retirement.  Lenders will want to see minimum 3 months' reserves, 6 months when you start into 5+ loans, and most will count your 401K balance as your reserves.  It also has more protection as far as liability issues or lawsuits -- I'm not a lawyer, so no legal advice, but I have been told it's much harder for anyone to take that from you in a lawsuit.   Consider both the tax savings and the employer match, and at least contribute up to the matching until you get a nice reserve fund built up.  You can always stop contributing later.        

My wife still has a regular job and her job matches her 401k contributions, so it's pretty much a no brainer to invest there. 

But the rest of our money goes into buy and hold REI. I'll take properties owned free and clear throwing off a good ROI annually over the stock market roller coaster. I respect all other opinions in this matter. That is what I believe :)

@Roy C.

I spent about 7 years contributing to a 401K while grinding in a corporation.  A few of the years I maxed my contribution and glad I did.  

To me retirement accounts are just another piece to the puzzle.  I have borrowed against it to buy property and it has been used as reserves in the eyes of many lenders I have used.  My plan is to never need a retirement account because my properties and web of businesses will be creating enough cash.

Frank

Frank Romine, Real Estate Agent in CA (#01957844)

it's been mentioned a lot and worth repeating, get the free money i.e. the employer's match. If you were to leave that job you can use that 401k and roll it into a self directed IRA to be used for REI

I have been thinking about this lately and my company does not currently match.  I just became eligible for the program but am not sure yet if I should get in.  Anyone have any scenarios where their company didn't match and what they decided to do? 

I'm assuming you're much younger than I.  Personally, at your age, I would at least contribute up to the employer-match amount into the company 401(k).  I would also allocate a certain amount of money toward educating myself on stock market analysis from a reputable source (i.e., not from a seminar series).  When I was an employee, colleagues were always amazed at how I got out (went to cash) before a major downswing.  While some saw their retirement shrink by 60%, mine remained stable and grew.  I was always [privately] amazed at their lack of education in the most important facet of their lives (their retirement money), and their unwillingness to invest time learning how to control this facet of their future.

As for investing in real estate, that's something I do now [that I'm retired], as the financier... without assuming the flipper's risk of  improperly estimating repair costs, missing a critical factor during inspection, etc.  Having invested in real estate in the mid 1970's (during one of the major down-turns), I quickly learned to follow my own path and ignore the noise from the crowd.  Ask anyone who invested right before a collapse in housing, and they'll tell you investing in real estate is a bad idea.  Ask anyone who's just starting out and making great money at it, and they'll tell you it's a good idea.  That should be plain and obvious.  As a result, your goal should be to learn when to divest yourself of one asset class (housing) in favor of another asset class (stocks, etc).  Most investors lack flexibility and knowledge of multiple asset classes, and therein lies their weakness (and long-term ineffectiveness).

As an aside, I believe "diversification" is for the common person who lacks the time and/or motivation to study and understand the complexity of financial markets.  I do not diversify, I invest heavily in asset classes that are outperforming the average.  I use options and futures to hedge my risk, just as you use auto insurance to hedge your bets.

Updated about 3 years ago

"up to at least the employer-match amount, and if possible, twice the employer-match amount (which equates to a 50% return on your money for the first year)."

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