What would I do? Buy investment property or invest in the stock and bond market?

80% of the time I would invest in the stock and bond markets.

Why?

• From time to time you'll hear people say that "owning real estate takes deep pockets". It does. Numerous things can go wrong with a property, and each time it will cost you money. Until you have a significant amount of liquid assets, I would choose to continue to invest in the stock and bond markets over buying investment property.
• From a diversity standpoint, you take on a large degree of risk when you purchase a single piece of investment property.
• It takes time to find renters and maintain a property. I'd rather use my time doing other things.

What About The Other 20%

• If I were in the real estate or property management industry I would consider buying investment property because I would have a greater degree of knowledge about how to do it.
• If I had sufficient liquid savings that I could make a down payment, have cash reserves just for that property, and maintain my normal emergency fund, then I would consider buying investment property.
• If I were in one of the highest tax brackets, I would consider buying investment property sooner than if I were in a lower tax bracket, as most investment properties generate a tax loss (due to depreciation) that can be used to offset other forms of income.

The nice thing about owning a rental property: essentially you are purchasing an asset with someone else's money. If you are in a high tax bracket, have sufficient liquid assets, and the time and energy to find the right property, than I think rental real estate can be a great addition to an investment portfolio. I just don't think those three criteria apply to most people.

It seems many upcoming retirees come in to our office and tell us, "Well, I've only got five years."

"Really?" I ask, "Are you terminally ill?"

They look at me funny and say, "No, no, that's when I want to retire."

It always puzzles me that people confuse their investment time-horizon with the amount of time they have until they retire. After all, I hope they plan on living for quite some time after retirement, which means their investment time-horizon could easily be thirty plus years... not five.

They way you invest for a thirty year time-horizon is substantially different than the way you invest for a five year time-horizon. If you need to use all your money in the next five years, put it all in safe investments.

If you need your assets and your income to keep pace with inflation over a potentially long time-horizon, you'll need to look beyond safe investments; instead thinking about placing your funds in short, medium and long term buckets, each designed to provide you with income for a certain decade of your upcoming life. I describe such a philosophy in Strategies For Creating Retirement Income From A Portfolio. You could also layer a small allocation (less than 15% of your total portfolio) to high yield investments as part of a long-term strategy.

Remember, one of the simplest ways to pick the right investments is to match your investments with your true investment time-horizon. Short term investments for short term needs; long-term investments for long-term needs.

Every Friday (last week a day late... this week... a day early) I post a "What Would I Do" topic. Keep in mind, it is not necessarily what you should do. Instead, it is written to give you insight into how to think about various financial decisions, understand the variables involved, and then, from an educated perspective, you can make the right decision for you.

So, what would I do, buy individual stocks, or stock index funds?

95% of the time I would buy stock index funds.

Why?

• Very simply put, with an individual stock, you can lose all of your money. With a stock index fund, for you to lose all of your money, the hundreds of companies listed in the index would all have to go out of business at once. If that happens, we've all got bigger problems on our hands than how much we've saved for retirement.
• To effectively manage a portfolio of individual stocks it takes a significant amount of time and research, and the odds are you will still end up with the same or lower return than if you had just bought an index fund.
• I prefer the simplest way to accomplish an end result and index funds provide a simple, low cost way to build a diversified portfolio.

What about the 5%?

• If I enjoyed stock trading, I would set up a play account in which I could buy and trade stocks. I would fund it with a dollar amount that was small in relation to my overall investment portfolio.
• If I worked in the investment industry, had earned my Certified Financial Analyst certification, and felt very confident in my ability to research and make unemotional investing decisions, than I might use individual stocks for a larger portion of my portfolio.

Learn More:

• Risk In A Stock Verses Risk In An Index Fund
• What Is An Index Fund And Why Would I Use One?
• Best Index Fund Families

We have a client who comes in each year and tells us they want to retire in five years. Each year we tell them what they would need to save on a monthly basis to make that happen. They tell us that's what they are going to do. A year later, they come back, and they have hardly saved at all.

After several years of this we are not sure what to think. What is it that they really want? A better lifestyle now... or early retirement? There's nothing wrong with either choice. But there is something delusional about saying you want something, and on an ongoing basis taking no significant steps to achieve it. So, if you think you don't have enough to retire when you want to you've got four choices:

• Work Longer
• Save More Now
• Earn A Higher Rate of Return (which means taking on more risk)
• Reduce Expenses So You Can Retire On Less

There it is. If you don't want to take any of those steps, then plan on a later retirement date. It's that simple.