Within a few of my writings, I have utilized a 12% and 15% return on investment per year to emphasize how quickly your money can grow with interest. Some of you might think that this was a bit far-fetched and asked that I would use a lower percentage such as 4% or 5%. I do understand where you are coming from; I mean, if you put your money into a savings account, you’ll only get around 0.25% interest, and if you have your money in the market, you may only be receiving 3-4%, if anything at all. But, I still stand by my percentages, mainly because I see these gains happenin all the time, just not in the way you might think.
There are too many individuals that blindly put their retirement money into a 401(k) plan that might be yielding them nothing. They’ll get their quarterly statement and see that they didn’t make very much money; they’ll make a couple of changes and then continue adding money into the same fund year after year. It has been said that mutual funds have natural diversification built into their model, and while that is partially true, 100% of your money is still in the stock market and therefore is hardly diversified at all.
Real Estate Investing
I have been in love with one type of investing for a long time, and if you are looking to diversify away from the stock market, I suggest that you look into purchasing property (and having other people pay for it). That’s right; I’m talking about Real Estate Investing.
There are two ways to invest in real estate: 1) Purchasing the real estate with cash or 2) using the bank’s money to fund the investment. Personally, I am always an advocate of cash purchases and steering clear from debt, but I also see the benefit of borrowing money to improve your return on investment.
Let’s start with method #2: Purchasing Real Estate by Borrowing
Your investment property is purchased at $100,000. You put up $10,000, and the bank loaned you $90,000 that you’ll repay after 30 years. Your monthly payment is $500 (very typical given today’s low home loan interest rates), and your rent is set at $1,000 per month (the typical 1% of the home value).
Assuming that your home will increase in value by 3% each year, that your house is rented for 10 out of the 12 months, and that there are general expenses of $2,000 each year, let’s see how well your investment did.
With a $5,000 profit, your return on your investment is 50%! Not too bad, huh?
Time to take a closer look at method number #1: Purchase Real Estate with Cash
You might be thinking, “Who has $100,000 in cash to put into an investment property?!” Well, if you have been out of college for 10 years, then YOU probably should! You would have only had to save about $800 per month, and for some people that I work with, that’s about the amount of their car payment.
So you buy this $100,000 house with cash and all of the income and expenses are the same as our previous example. Let’s check out the resulting numbers:
As you can see, the profits are greater because there are no mortgage payments, but because the initial investment is 10 times more than the previous example, the return is actually only 11%.
Before you start running off to the bank and borrowing all the money you can, please understand that things can also go very wrong when you dig yourself into debt. What if the housing market flopped (we have all seen this happen recently)? Let me show you what could happen.
If the market took your house value down 10%, you would have a loss of $8,000 for the year and would almost owe more on the house than it was even worth! If you would own the house, you would only have a loss of $2,000, and you wouldn’t have to worry about having an upside-down mortgage!
If you have read this article completely, you should now understand that a ROI (return on investment) can easily be larger than 4% or 5%.
Do you think you’ll ever invest in real estate? If so, what’s your plan?