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  • Nate Carter

Retirement Savings: Comparing a 401k to Real Estate

Building a diversified portfolio with multiple income streams is a great strategy for financial freedom and early retirement. Income diversification makes it easier to navigate market downturns by relying on the income streams experiencing less volatility.

A 401k account is a practical and tax efficient way to invest in stocks and bonds for retirement. 401k contributions can be automatic along with the investment allocations. And many 401k plans offer an employee match, which is an immediate and risk free return on your contributions.

Rental properties are a nice complement to 401k accounts, providing both real estate appreciation and rental income. Rentals require more of an investor's time, but as an asset class they can provide excellent returns. This is due to leverage which allows an investor to acquire a property with a modest down payment, but benefit from the entire property appreciating.

For example, if a $200,000 property bought with a $20,000 down payment appreciates in value by 5% it is now worth $210,000. The investor has earned $10,000 or 50% on their $20,000 down payment. The key to success with real estate is to only take mortgage debt you can responsibly manage.

Below is a comparison of using a 401k and a rental property to save for retirement. The figures below are based on actual returns, but keep in mind future returns will vary based on market conditions.

Real Estate Example

In 2013 our investor, whom we will call Danny, began researching cities with undervalued real estate. He looked for places where property values would likely increase due to rising populations and job growth. He found a location he liked and bought a single family home which became an investment property in January 2014.

He paid $385,000 with a 10% down payment of $38,500. He paid another $4,500 in closing costs for a total investment of $43,000. He financed the property with a 15-year fixed rate mortgage. (Note: lenders will generally want a down payment of 20% for investment properties). In the first year the rents covered the mortgage and expenses, but offered little profit.

Danny's analysis of the region proved correct and the properties quickly appreciated in value. When his equity in the property reached 20% he was able to remove the private mortgage insurance, saving $170 per month. He also raised the rent, which earned him a few hundred dollars in monthly profit. He used these profits to pay down the mortgage balance. He worked with a property manager to mange the property, find new tenants as needed and make necessary repairs. Overall, he found the time commitment for this investment to be manageable.

In January 2022 eight years have passed. Danny's loan balance is $150,000 and his total investment is $71,000. This includes the $43,000 from buying the property and $28,000 in rental income he used to pay down the mortgage. The rental income continues to cover the monthly mortgage payments, so Danny has not put any more of his own money into the property.

The property is now worth $1 million giving him equity of $850,000 after subtracting his mortgage balance. He continues to earn a few hundred dollars a month in rental profits which he uses to pay down the mortgage.

401k Example

Danny started with his current employer in 2000 and immediately began contributing to his employer's 401k plan. His employer also matched part of his contributions helping his savings grow. Unlike real estate, a 401k can be a very passive investment. Danny's contributions are automatically taken out of his paycheck. He invested primarily in low cost stock index funds, but more recently added some bonds to his portfolio.

As of January 2022, Danny contributed a total of $326,000 to his 401k over the 21 years. His portfolio is now worth $1 million with $674,000 coming from appreciation, reinvested dividends and his employer's matching contributions.

Comparing Real Estate to the 401k

Both of these investments provided Danny with an asset worth $1 million. He also earns passive income, in the form of rents from the property, and dividends/interest from the stocks and bonds. With real estate Danny was able to turn $71,000 into $850,000 over eight years. This was an excellent return, but not unique for real estate over the last decade. Once the property is paid off in a few years he expects to earn at least $40,000 per year in rental income after expenses.

Danny's 401k helped him save $1 million for retirement. It took his 401k portfolio about 18 years to reach $850,000 which was a decade longer than his real estate investment. Also it required about $50,000 more in 401k contributions to get there. But, one of key advantages of his 401k was that he could start from his first paycheck without any prior savings. With real estate he needed to save for a down payment.

And although the 401k returns were lower, it was still a wise investment decision. It allowed Danny to save on his annual taxes each year by sheltering part of income. When he eventually pays income tax on his 401k withdrawals he will be in a lower tax bracket because he will have retired. The 401k also allows Danny to diversify his retirement savings with a solid portfolio of stocks and bonds. He expects this portfolio to also generate $40,000 a year in income when he retires.

Future Plans and More Income Streams

Danny still plans to work for the next decade and will be able to save more in a 401k with his new employer. He is also looking to add one or two more rental properties to bolster his future rental income. Over time he wants to start a small business to create a third revenue stream. When he reaches age 67 he will be eligible for Social Security Retirement Benefits which will provide a fourth income stream. Danny is very close to reaching his goal of financial freedom. More importantly he is doing it with multiple income streams which will provide for a more secure and durable retirement.

For more on creating diversified income streams for financial independence and an early retirement see Become Loaded for Life and the 10 Stages Workbook.

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