The Importance of Building Savings Habits Early

The Importance of Building Savings Habits Early

We’re taught to save money from the time we get our first tooth fairy payment, but when we’re young, saving doesn’t always seem necessary. A common belief is that saving is for people who are getting ready to buy their own house, put their kids through college, or retire.

In reality, it’s better to start saving long before any of these things happen, for several reasons.

 

Why Saving Money Early Is Key

First, it makes savings a habit. Take the tooth fairy profit, for example. The quarter a six-year-old saves from the dollar she found under her pillow isn’t going to fund her college tuition (a child only has so many teeth, you know). But having her tuck that little bit away in a savings account or piggy bank will get her into the habit of saving a little from everything she is given or earns in the future. The same goes for high schoolers and college students. Saving some of their summer job pay or internship income will prepare them for saving when they enter the work world full-time. Opening a Roth IRA sooner rather than later can be one of the best financial decisions that a young person can make.

Second, you may actually have more money now rather than later. A recent college grad just starting their full-time career or a young newly married couple may find this hard to believe, but they may have more expendable income now than they will in 10 or 20 years. Just as their income will most likely increase over the years, so will their expenses. Moving out of an apartment into a house increases maintenance and utility costs. Having kids not only adds expenses like additional food, clothing, and medical bills, but parents also often find themselves needing larger cars and more living space to accommodate their growing family. If both parents decide to keep working, they are likely to incur childcare costs; and if one of them leaves the workforce to parent full-time, that income is lost.

Lastly, it allows the power of compounding to work to its fullest. Starting to save as a child or young adult obviously gives you more time to save than if you wait until middle age. Investing this savings early allows compounding to work its magic. As an example, assuming a constant 6% annual rate of return, if a 25-year-old invests $10,000 a year for 10 years and then stops while a second person waits until age 35 to invest $10,000 a year for 10 years, the first person will have accumulated almost twice as much in total savings by the time they are both 45.*

So even if you aren’t planning on staying forever at your first full-time job right after graduation, participate in the company 401(k) plan as soon as you’re eligible. If there is a company match, invest enough to take full advantage of it. If and when you leave you can take it with you by rolling it over into an IRA which will allow your money to keep growing wherever you go. If your employer doesn’t offer a 401(k), you can still almost always save by payroll deduction to a separate retirement account. And the best part about saving through payroll deduction is that you won’t miss the money because it doesn’t appear in your bank account.

It’s important to pay yourself first – even before Uncle Sam, the landlord, the utility company, or the grocery store. There will always be money left for them, but there may not be for you if you don’t make this basic discipline a priority. Saving early will get you in the habit and give you a huge head start!

*This is a hypothetical example of mathematical compounding. It’s used for illustrative purposes only and is not intended to represent the past or future performance of any investment. Taxes and investment costs were not considered in this example. The results are not a guarantee of performance nor represent specific investment advice. Actual returns will fluctuate. Investments that offer the potential for high returns also carry a high degree of risk. 

A Household Spending Plan to Save for Retirement

A Household Spending Plan to Save for Retirement

“I’m Too Busy to Plan for Retirement”

Like all of us, you’re busy. Retirement is a fuzzy, distant event that has nothing to do with shuttling the kids to lacrosse practice or dance lessons while making sure family members with five different schedules manage to eat a semi-healthy dinner every night.

Maybe you’re a professional, dutifully saving 3% of your salary into a 401(k) every year and getting 3% on top of that in matching funds by your employer. This is better than most Americans: this rate of savings will fund a retirement in some form, but probably not the retirement you want. Saving at least 10% of your income (or more if you’re getting a later start) is often what’s required given the increasing likelihood that you’ll live to 85, 90 or possibly even 100.

Why I Hate “Budgets” and Love “Spending and Saving Plans”

What comes to mind when you hear the word “budget?” Either it feels like an exercise in denial or it feels like a tedious, hours-long exercise of tracking where every single nickel is going in your household.

While scrupulous tracking may be required if you are in genuine financial crisis, it is not required if you have some money in the bank and are already saving at least a small percentage of your income each month. However, if you’re looking to save more for retirement and get yourself up into that 10% to 15% range that is required to fund what will likely be a retirement of 30 or more years, I do recommend having a simple spending and saving plan in place to help you get there.

With my busy clients, I’ve found the plan needs to be easy to set up and maintained in an hour or two per month; otherwise, like many other good intentions, it will get thrown overboard in the daily scramble. This household spending plan will have you off and running in a few hours and can be easily maintained once a month to help you meet your retirement savings goals.

 

Step 1 – Set Your Retirement Savings Goal

If you’re still in your 20s, consider setting a savings goal of 10% of your income. If you’re in your 30s or beyond and don’t have a lot saved for retirement, think about how you can get to 15% or more.

This may seem a little intimidating, given all the categories of expenses that are competing for your paycheck. If so, rather than setting a final percentage goal (10% or 15%), make a commitment to increase your savings rate by 1% a year until you get to your final target.

 

Step 2 – Establish Your Spending Categories

Make a numbered list of all of your household spending categories. Lump things together as appropriate. For example, your heating bill, your power bill and your water bill can be combined under the category “Utilities.”

Separate other things that you think should be tracked separately. For example, consider separating “Dining Out” from “Other Entertainment” and “Food/Household Supplies” if you suspect you may be overspending in restaurants. Create no more than about 20-25 categories. Sample budget categories are included at the end of this exercise.

 

Step 3 – Make Some Super-Rough Spending Guesses

Spend no more than 10 minutes going through your list and making some super rough guesses on how much you spend in each category.  Do not get out any old bills, credit card statements or a calculator at this point. Put the spending categories into three buckets – big expenses, medium expenses and small expenses. The purpose of these guesses is simply to group expenses into the categories, not to understand where every dollar is going.

 

Step 4 – Choose Your Spending Plan Targets

Use the Spending Grid Tool below to help you decide which spending categories you will target for reduced spending. For each numbered spending category, draw an appropriate bubble on the grid.

Big expenses should go toward the top of the graph and little ones should go toward the bottom. Similarly, expenses you’d find easier to reduce should go toward the right of the graph while those that would be harder should go toward the left.

Consider cutting any categories that fall into the upper right quadrant (that is, categories that have a large budget and which you would find easy to cut). An example of this might be the $5 cup of coffee you purchase on the way to work each day. If you switch to making coffee at home most days and taking it with you in a travel mug – thus reducing your coffee purchase to once a week – you could save about $15 a week, or approximately $750 per year, with the same end result of being able to drink coffee every morning.

At the end of the exercise, you should have one to three categories that are your Spending Plan Targets for reduction.

 

Step 5 – Now Get Out the Statements, Bills and Calculator

Now that you’ve identified your one to three categories that are your Spending Plan Targets, do a detailed assessment of how much you spend in each category. Go back through three months of statements and calculate an average for each. Then, figure out how much you need to reduce spending to meet your goal.

Here’s a simple example. Let’s assume that you:

  • Have a household income of $100,000.
  • Have a goal to save 1% more of your income toward retirement this year, or $1,000, which translates to $83.33 per month of required savings.
  • Identified two Spending Plan Targets – Dining Out and Clothing – as your areas of focus.
  • Are currently spending $320 per month Dining Out (including those runs to Starbucks) and $250 per month on Clothing.

You could target reducing Dining Out by $50 per month and Clothing by $35 per month to meet your $83.33 per month savings goal. This would make your new targets $270 per month for Dining Out and $215 per month for Clothing.

 

Step 6 – Monitor Actual Spending in Each Category for Three Months

When your credit card statement or other bills come in each month, record how much you actually spent in each of your Spending Plan Target categories.

If you’re having no problems staying within the new limits you’ve set over a period of three months, then bump up your retirement savings to your new goal.  Congratulations!

If you find you are having problems, consider doing one of the following:

  • Run the experiment for another three months. If it’s still not working after six months, consider adding an additional category or two to your Spending Plan Target list to get the savings you need.
  • Try the “Cash Envelope” method. Using the numbers above, put $270 into your Dining Out envelope and $250 in your Clothing envelope. Always pay with cash for expenses in these categories. Once the money runs out in the envelope, spend no more in that category for the month. Money left in the envelope at the end of the month can be carried over. There is no shame in needing to use this approach – I personally know of households with incomes over $100,000 who have successfully used this method to get their spending on track and meet their retirement savings goals.

This simple system should take you no more than two hours to set up and an hour a month to maintain. It is time well spent to know that you’re meeting your savings goals and are on track for retirement!

How Much in Savings You Need to Live Comfortably

According to the Federal Reserve’s study on economic well-being in U.S. households, published in 2016, Americans are satisfied with how they are doing financially. The number of adults reporting they are “living comfortably” or “doing okay” rose to 69%, up from 65% in 2014 and 62% in 2013. However, surveyors then asked a series of follow-up questions that called into serious question what most Americans perceive as comfortable. For example, 46% of study participants admitted that if an unexpected expense costing $400 arose, they would be unable to pay for it without selling property or borrowing money. Of the 22% of respondents who incurred an unexpected medical expense over the previous year, nearly half, or 46%, still had debt from that expense.

It’s difficult to rationalize the impressions most Americans have of their financial situations with actual numbers. Simple math indicates sizable overlap among those who claim they are doing fine financially, yet could not pay out of pocket for a basic car repair. This calls into question whether $400 in savings can support a comfortable existence. It also raises other interesting questions, such as how much in savings is truly sufficient to be financially secure, and how this number may vary based on a person’s stage of life and living standards.

Minimum Savings for Comfortable Living

Financial guru Dave Ramsey, who advocates debt-free living and financial security, advises $1,000 in the bank as a starting point for clients who are destitute or currently have no savings. This sum, though insufficient to live on for long if an income loss occurs, at the very least prevents a car breakdown or minor medical mishap from causing a financial disaster. Despite the high level of financial security self-reported by the majority of Americans, nearly half lack this basic first step for an emergency fund.

Three-to-six months of living expenses represents a more comfortable nest egg. Three months of expenses is a sufficient emergency fund in periods of low employment, assuming the person possesses high-demand skills. This level of savings is particularly secure if the person is willing to cut back on discretionary purchases and live a frugal lifestyle. Those with fewer marketable skills and those who have fewer expenses that they are willing to forgo should aim to keep a full six months’ expenses in savings.

Other Considerations

The exact amount that constitutes comfortable savings varies based on a person’s unique circumstances. A person with children requires a bigger cushion, since that person is responsible for providing for others. A single person with no children needs less in savings, particularly if he or she is willing to live a bare-bones existence or take any job that is available in a pinch.

A person who still lives at home with parents and has no expenses, or who shares a dwelling with several roommates and has minimal expenses, can more comfortably cut savings than someone who has a stack of bills to pay every month. Of course, many people in these situations find it an ideal time to put money away, perhaps saving up for a house down payment at a later date.

Similarly, a person’s debt load influences how many months of income represent sufficient savings. For example, if 30% of a person’s take-home pay goes toward debt payments each month, that person clearly needs more savings than a debt-free person.

Every person is unique when it comes to his financial needs. No matter the dollar amount of a person’s savings, what matters is the ability to stave off financial calamity for as long as needed in the case of a job loss or income reduction.

Is Investing $25 a Month Worth It?

Any time you move money from your checking account to another account, whether it’s an individual retirement account (IRA), investing in stocks, mutual funds or savings account, you’re making an important step toward a financially secure future.

But what if you only have $25 a month to invest? Can you still secure your financial future? Or is it better to put it into a savings account until it’s large enough to counteract fees? This article will explain how to evaluate fees involved in small investments.

How to Translate Fees Into a Percentage of a $25 Investment

Saving $25 a month will total $300 in a year, not including any interest. A $40 fee on an investment account equals more than 13.33% of your investment. Thus, this $25 investment would have to earn more than $40 in a year just for you to break even. This means that if the fee was taken out at year’s end, you would have to earn a 27% return on your money to break even. Why 27% instead of 13%? The reason is because your money grows steadily, and you earn interest on the amount you have in your account. For example, after one month you’ve invested $25, after two months you’ve invested $50, and so on. As your account grows, the principal on which the investment earns interest grows.

Therefore whether a fee is charged for buying stocks or mutual funds, maintaining or opening an IRA, or a savings account where your savings isn’t higher than the minimum balance, you have to consider whether the fee offsets the benefits of your investment. The easiest way to figure out if your fee is too high for your investment is to calculate how much money is necessary in interest or profit earned to offset fees. For instance, if you invest $25 per month, $3 equals 1% of your yearly total of $300 invested. Divide any fee by $3 to figure out the percentage you would have to earn to overcome the cost of having the account.

If you are investing a different amount, multiply your monthly investment by 12. Then, divide the result by 100. This tells you what 1% of your investment is.

Investing Directly With Mutual Fund Companies

Cut the amount of fees you incur by setting up an investment account directly with mutual fund companies. You can contact mutual fund companies through their websites or by phone and avoid the fees charged by brokerage firms or financial advisors. This is a good choice when you don’t have much money to manage.

A pitfall of investing small amounts through this investment avenue is that you are subject to losses. It is similar to investing in stock in that your principal can decrease, or even be lost, based on how the stocks or bonds in your diversified fund rise and fall. Therefore, make sure the amount you invest regularly, for example $25, isn’t money that you will need in the next two or three years.

Paying Off Debt

An alternative to traditional investing avenues is to invest in decreasing your debt load. For instance, you could add $25 to the minimum monthly payments you currently make on your credit card, which charges you a 12.9% interest rate. By doing this, you save roughly $3.23 per year for every $25 you pay off. When your debt is gone, you’ll be able to put more money into long-term investments and you won’t have to worry about a small fee eating up all your profits because your earnings will more than make up for the fee charge.

Decreasing Your Mortgage Balance

If your home is tied to a 30-year, $150,000 mortgage loan with a fixed rate of 6%, sending in an extra $25 per month with your mortgage payment will cut approximately two years off your mortgage repayment term. There are two reasons for this:

  • You’re paying down your principal. For every $25 you pay off, that’s $25 dollars less you owe on your mortgage.
  • The amount of interest you pay on the amount of principal you pay off is eliminated for the rest of the term of the loan.

For example, suppose that you have a balance of $148,000 on your 30-year home loan after your first payment, and you decide to send in an extra $25 this month. You now have a mortgage balance of $147,775. The $25 you just paid off will save you $143.59 over the life of your 30-year mortgage at a fixed 6% interest rate.

As a bonus, you’re essentially saving for retirement by helping to insure that you won’t have to make mortgage payments after you retire if you stay in the same home.

The Bottom Line

Putting aside $25 a month to invest in a savings account, mutual fund or individual retirement account is a worthwhile venture. However, pay extra attention to make sure profits counteract fees. Also, consider alternatives, such as reducing your credit card debt or amount owed on your mortgage loan, that will allow you to invest larger amounts in the future.

Top 10 Fastest Growing Industries in the United States

Construction in the United States is on the upswing. Seven of the top 10 fastest-growing industries in the country are related to construction. This data comes to us by way of the financial data provider Sageworks, which has compiled a list of the fastest-growing industries based on annual sales increases. This year, computer systems design and related services tops the list, followed by a variety of construction and utility-related industries.

1. Computer Systems Design and Related Services

This industry is far and away the fastest growing in the U.S. As quoted in Forbes, Sageworks analyst James Noe said, “There’s just an obvious need in the economy for these types of services. Everyone uses computers and businesses rely heavily on technology now, so in my mind, it’s a no-brainer that these types of services are growing fairly quickly.” According to a 2012 report from the U.S. Department of Labor’s Bureau of Labor Statistics, a 15 percent rise in employment in this field is expected from 2012 through 2022. Looks like that’s on track, with 18% growth last year.

2. Services to Buildings and Dwellings

This industry is comprised of all the establishments that provide services necessary for the maintenance of a property – cleaning (inside and out), extermination and pest control, as well as landscaping and outdoor construction, like decks, stone retaining walls, and fences. These services saw a 14% sales increase from January to December of last year.

3. Building Finishing Contractors

The industry’s name is rather self-explanatory, these contractors do the work required to finish a building, whether that’s additions, alterations, maintenance or repairs. This industry, too, saw a 14% increase last year.

4. Residential Building Construction

This includes construction, remodeling and renovation to both single family and multifamily residential buildings. 14% growth last year.

All of the next five industry categories saw 13% growth last year.

5. Foundation, Structure, and Building Exterior Contractors

The contractors who install the wood products above among other duties made up the fifth-fastest growing industry in 2016. This category consists of the specialty trades working on the foundation, frame, and shell of buildings.

6. Other Professional, Scientific, and Technical Services

These are jobs that require a high level of education, training and expertise. The services provided come in the form of legal advice, technological expertise, accounting, research, consulting, advertising, photography, translation and interpretation, as well as a number of others. Since computer systems design and related services are listed further up, we would have to imagine this category does not include growth in that particular technical service.

7. Building Equipment Contractors

With all of this construction, these buildings need to have internal work done, as well. This includes electricians, wiring installation contractors, plumbers, and heating and air-condition contractors.

8. Other Specialty Trade Contractors –

Specialty trade contractors consist of carpenters, brick and stone masons, tile and marble setters, roofers, drywall installers, sheet metal workers, ceiling tile installers, and many more.

9. Nonresidential Building Construction

Buildings and developments in this category include hotels, amusement parks, stores, office and public safety buildings, industrial facilities, schools, healthcare facilities, and churches.

10. Other Heavy and Civil Engineering

This industry is comprised primarily of two sectors, “establishments whose primary activity is the construction of entire engineering projects (e.g. highways and dams), and specialty trade contractors, whose primary activity is the production of a specific component for such projects,” according to the Bureau of Labor Statistics.

The Bottom Line

More than half of the top 10 fasting growing industries are directly related to new-home construction. Non-residential building construction is also part of the list. The construction industry, in general, may be one to keep an eye on, given these signs of an economic recovery.

This Is the Secret to Organizing Your Finances

This Is the Secret to Organizing Your Finances

The first step when organizing your finances is to determine what it is you would like to accomplish. After your goals are set, the most important thing you need to take a good look at is your cash flow, so that you can figure out the necessary steps to fund your goals. I suggest doing this in three steps:

  1. Add up how much you are spending.
  2. Figure out how much you earn and pay in taxes.
  3. Subtract your expenses and taxes from your income to calculate your discretionary income.
This is a cash management analysis. It does two things: it brings awareness to your spending habits, your taxes, and your income, and it allows you to plan accordingly. By plan accordingly, I mean that when you are faced with a decision to buy a new or used car, to buy a bigger home, or even just to add a monthly cable bill to your expenses, you’ll know exactly how that is going to impact your cash flow. So let’s explore how to figure out your cash flow in a little more detail.

Spending

The best way to know where you are spending your money is to import all your credit card and banking transactions from the last four months into a free online budgeting software program. I prefer Mint.com, but there are several out there, including, Yodlee.com, MySpendingPlan.com, and others. Once you’ve opened an account and have imported your transactions, you can look at your spending trends. As you get more data, you’ll know how much goes towards food, auto and housing expenses. This also tells you where you can lower your expenses if needed.
If you’re interested, you can compare your spending habits with that of the rest of the country by looking at the latest Consumer Expenditure Survey. Mint does a nice job of suggesting ways to save money on credit card interest and fees, insurance rates and other expenditures.

Income and Taxes

The best way to compare your earnings and tax bill is to look at Total Income on line 22 of last year’s tax return. Subtract line 60, Total Tax and any state or local taxes from their respective returns to determine your after-tax income.

Discretionary Income

Now subtract your expenses from your after-tax income to determine how much you have available to fund your goals. This will let you know if you are living above or below your means, and how much you have left to allocate towards your savings goals.
This analysis lets pre-retirees know how much they can save, and what they may need to have a steady income in retirement. And it can prevent retirees from running out of money because they will be able to determine if they are spending more than their portfolios can handle. Whether you are a pre or post-retiree, once you are aware of where your money is going, you can more easily make conscious decisions with your money. Finally, my parting thought: the best way to lower your expenses is to cut out unnecessary items and reduce big ticket items, such as cars and homes.

Is Now A Good Time To Invest In Real Estate?

Although mortgage rates have recently risen slightly from their all-time lows, the recovery of the housing market is not a reality in many areas of the United States. This means that houses in several different states cost less than they have in years and rates are still low enough to make investing in real estate a popular consideration for many investors. But is this really a good time to be investing in property that you won’t be living in? After all, there are many things to consider beyond the opportunistic aspects of the decision. (To learn more about investing in property,

Carrying Costs
Carrying costs for an empty property meant for resale don’t just include the monthly mortgage payment. They also include insurance costs, property taxes, upkeep and repair expenses. Even if you plan on renting the property before it is sold, you still need to have adequate cash reserves to pay all of these expenses because the rent you are able to charge in your area might not be enough to provide adequate resources. Finally, consider how long you may need to cover these costs. When the housing market was booming and houses were easily flipped, carrying costs might not have been a concern; but now, when houses can sit on the market for months or years, they are.

Risk and Return
The discussion above about carrying costs gives an indication of the amount of risk you might be taking on when you invest in real estate. Conventional investing wisdom says that real estate is an investment that will grow over time, but recent years have shown that this growth may not be as straight forward as an investor might want. Additionally, after paying the mortgage interest, insurance, property taxes and maintenance expenses for a number of years, the return made when you sell the property for more than you purchased it for could be much less than you anticipated because your cost basis is comprised of more expenses than just purchase price and interest. (Can investing in real estate help your portfolio?

Liquidity
Real estate is not generally considered a liquid investment because it is not easily sold for cash, and in a restrictive financial environment, real estate is even more illiquid. Even if you just need to pull some equity out for an emergency, assuming you have any equity,the restrictive lending environment could mean that you have difficulty accessing any cash.

Investing Goals
Your personal investing goals and timeline will have a lot of bearing on whether or not real estate is a good investment for you right now. If you are within a few years of retirement, investing in real estate could actually push your retirement back until a later date, especially if you tap into your retirement savings for the down payment. In addition, if you have to carry the property for a great deal of time, it could reduce the amount of money you can save and your subsequent earnings on those savings. If you have a longer-term saving plan, then you might have more flexibility to add something as unpredictable as real estate to your financial plan. (For more way to invest in real estate,

The Bottom Line
Often, a “good time to buy” for one investor may not be for another. Sure, opportunities for return abound, but if it isn’t actually a good time for you to invest then the opportunities that you see will not be something that you can trust to provide an opportunity to you. Instead, they may turn into financial mistakes and burdens that you have trouble keeping up with. When evaluating the potential of investing in real estate, don’t just think about home prices and interest rates; take the time to consider your personal financial situation and whether or not you can afford the long-term commitment a real estate investment might entail. (To increase your chances of success in real estate

How to Invest in Real Estate Without Buying Property

Investing in real estate can be very lucrative; however, getting started in real estate investments requires a large amount of capital. That being said, if you do not have hundreds of thousands of dollars on hand, there are other options to invest in real estate without buying a physical property. (For more, see: What Are the Differences Between Investing in Real Estate and Stocks?)

Invest in a REIT

A REIT, or real estate investment trust, is a company that owns and manages real estate and related assets, such as mortgages or mortgage bonds. The majority of a REIT’s income and assets must be linked to real estate. To qualify as a REIT, companies must meet these standards, plus additional rules defined by the Securities and Exchange Commission:

  • Invest at least 75% of total assets in real estate assets
  • Derive at least 75% of gross income from property rent or mortgage interest
  • Have a minimum of 100 shareholders after its first year as a REIT
  • Have no more than 50% of shares held by five or fewer individuals
  • Pay at least 90% of taxable income as shareholder dividends

That last rule is significant for individual investors. REITs are not simply companies that own real estate; they are businesses that provide cash flow to their investors. If you invest in a REIT with dividend reinvestment, you can grow your portfolio until you reach a point where you can purchase individual properties yourself, or continue to invest in managed real estate portfolios. (For additional reading, see: 5 Types of REITs and How to Invest in Them.)

Invest in a Real Estate Focused Company

Many companies own and manage real estate that are not structured as a REIT. These stocks typically pay a much lower dividend than a REIT, but the companies have more freedom to reinvest profits to expand.

Some companies in other industries behave like a real estate company even though that is not the primary service they offer. Examples include hotel chains, shopping mall and strip mall managers, and resort operators.

Of course, there are traditional real estate companies available for investments as well. Companies include real estate services companies like RE/MAX Holdings Inc. (RMAX

RE/MAX Holdings Inc
RMAX
59.00
-0.09%

), commercial real estate operators like CBRE Group (CBG

CBRE Group Inc
CBG
37.44
-0.95%

), and shopping center companies like Equity One (EQY).As with any individual stock investment, always do plenty of research before making an investment decision. Investing heavily in one stock or industry relative to the rest of your portfolio opens you up to portfolio concentration risk.

Invest in Home Construction

Real estate is not just about buying and profiting from existing companies. There is an entire industry of homebuilders responsible for developing new neighborhoods in growing metropolitan areas. These companies may be involved with multiple aspects of the home construction process.

When evaluating homebuilders, look at all aspects of the business. Ask yourself if the company is focused on a region with poor real estate performance if the company is focused on only very high or low-end homes, and compare the focus to real estate trends.

Large homebuilders include Lennar Corp. (LEN

Lennar Corp
LEN
53.87
0.00%

), D.R. Horton Inc. (DHI

D.R. Horton Inc
DHI
36.33
-0.33%

), KB Home (KBH

KB Home
KBH
23.11
+0.17%

), PulteGroup Inc (PHM

PulteGroup Inc
PHM
25.29
+0.36%

), and NVR Inc. (NVR

NVR Inc
NVR
2,704.70
+1.09%

).Keep in mind that homebuilder performance can be highly correlated to the economy. When job growth is strong, people want to buy new homes. When the economy is sluggish, new home sales tend to fall.

Invest in a Real Estate Mutual Fund

One of the most difficult hurdles in real estate investing is diversification. As a retail investor in the stock market, it is not difficult to find diversity investing. Shares of many companies trade at a low enough price per share that achieving diversification can be reached at a reasonable price point through planning. Real estate is quite a bit different.

In real estate, a single asset typically costs well into the six-figure range. Only one company, Berkshire Hathaway (BRK.A

Berkshire Hathaway Inc
BRK.A
268,370.20
+0.61%

) trades at that level. Few stocks reach high into the three-figure level.To get diversification in real estate, investors can turn to real estate focused mutual funds, index funds, and ETFs. Some real estate funds work just like a traditional mutual fund, primarily invested in real estate stock. Others are focused on REITs or even direct purchases of real estate.

An example of a popular REIT ETF is the Vanguard REIT ETF (VNQ

Vanguard REIT Shs
VNQ
83.70
-0.20%

). This ETF trades just like a stock but gives you instant exposure to a portfolio of REITs. This fund holds 145 different stocks. Top holdings include Simon Property Group Inc. (SPG

Simon Property Group Inc
SPG
161.95
+0.36%

) and Public Storage (PSA

Public Storage
PSA
200.34
-0.93%

).If you prefer a real estate mutual fund, Prudential Global Real Estate Fund (PURAX) is a global real estate fund. The fund is 97.5% invested in real estate. 52% of holdings are in North America, with the remainder invested in Europe (17% of holdings), and Asia (31% of holdings). This fund is primarily focused on developed markets, with less than 2% of funds invested in emerging markets.

The Bottom Line

Investing in individual properties requires a lot of capital and comes with a high risk. Investing in other options available through the stock market, REITs, mutual funds, and ETFs can give your portfolio real estate exposure without having to lay out hundreds of thousands of dollars.

As with any investment, investing in real estate and related companies comes with some risk. Evaluate any investment option before buying to ensure it lines up with your investment goals.

American and global real estate have performed well in recent years, but not all markets are alike. Some real estate exposure provides an excellent hedge against other market fluctuations, but too much real estate concentration leaves you open to losses when the real estate market falters, as it did in the recent real estate bubble burst and mortgage crisis.

However, once you have a good understanding of your investment goals and how real estate can play a part, you can confidently invest and make real estate a portion of your portfolio for both short-term and long-term investment goals.

How to Invest in Real Estate Without Buying Property

 

Investing in real estate can be very lucrative; however, getting started in real estate investments requires a large amount of capital. That being said, if you do not have hundreds of thousands of dollars on hand, there are other options to invest in real estate without buying a physical property. (For more, see: What Are the Differences Between Investing in Real Estate and Stocks?)

Invest in a REIT

A REIT, or real estate investment trust, is a company that owns and manages real estate and related assets, such as mortgages or mortgage bonds. The majority of a REIT’s income and assets must be linked to real estate. To qualify as a REIT, companies must meet these standards, plus additional rules defined by the Securities and Exchange Commission:

  • Invest at least 75% of total assets in real estate assets
  • Derive at least 75% of gross income from property rent or mortgage interest
  • Have a minimum of 100 shareholders after its first year as a REIT
  • Have no more than 50% of shares held by five or fewer individuals
  • Pay at least 90% of taxable income as shareholder dividends

That last rule is significant for individual investors. REITs are not simply companies that own real estate; they are businesses that provide cash flow to their investors. If you invest in a REIT with dividend reinvestment, you can grow your portfolio until you reach a point where you can purchase individual properties yourself, or continue to invest in managed real estate portfolios. (For additional reading, see: 5 Types of REITs and How to Invest in Them.)

Invest in a Real Estate Focused Company

Many companies own and manage real estate that are not structured as a REIT. These stocks typically pay a much lower dividend than a REIT, but the companies have more freedom to reinvest profits to expand.

Some companies in other industries behave like a real estate company even though that is not the primary service they offer. Examples include hotel chains, shopping mall and strip mall managers, and resort operators.

Of course, there are traditional real estate companies available for investments as well. Companies include real estate services companies like RE/MAX Holdings Inc. (RMAX

RE/MAX Holdings Inc
RMAX
59.00
-0.09%

), commercial real estate operators like CBRE Group (CBG

CBRE Group Inc
CBG
37.44
-0.95%

), and shopping center companies like Equity One (EQY).As with any individual stock investment, always do plenty of research before making an investment decision. Investing heavily in one stock or industry relative to the rest of your portfolio opens you up to portfolio concentration risk.

Invest in Home Construction

Real estate is not just about buying and profiting from existing companies. There is an entire industry of homebuilders responsible for developing new neighborhoods in growing metropolitan areas. These companies may be involved with multiple aspects of the home construction process.

When evaluating homebuilders, look at all aspects of the business. Ask yourself if the company is focused on a region with poor real estate performance if the company is focused on only very high or low-end homes, and compare the focus to real estate trends.

Large homebuilders include Lennar Corp. (LEN

Lennar Corp
LEN
53.87
0.00%

), D.R. Horton Inc. (DHI

D.R. Horton Inc
DHI
36.33
-0.33%

), KB Home (KBH

KB Home
KBH
23.11
+0.17%

), PulteGroup Inc (PHM

PulteGroup Inc
PHM
25.29
+0.36%

), and NVR Inc. (NVR

NVR Inc
NVR
2,704.70
+1.09%

).Keep in mind that homebuilder performance can be highly correlated to the economy. When job growth is strong, people want to buy new homes. When the economy is sluggish, new home sales tend to fall.

Invest in a Real Estate Mutual Fund

One of the most difficult hurdles in real estate investing is diversification. As a retail investor in the stock market, it is not difficult to find diversity investing. Shares of many companies trade at a low enough price per share that achieving diversification can be reached at a reasonable price point through planning. Real estate is quite a bit different.

In real estate, a single asset typically costs well into the six-figure range. Only one company, Berkshire Hathaway (BRK.A

Berkshire Hathaway Inc
BRK.A
268,370.20
+0.61%

) trades at that level. Few stocks reach high into the three-figure level.To get diversification in real estate, investors can turn to real estate focused mutual funds, index funds, and ETFs. Some real estate funds work just like a traditional mutual fund, primarily invested in real estate stock. Others are focused on REITs or even direct purchases of real estate.

An example of a popular REIT ETF is the Vanguard REIT ETF (VNQ

Vanguard REIT Shs
VNQ
83.70
-0.20%

). This ETF trades just like a stock but gives you instant exposure to a portfolio of REITs. This fund holds 145 different stocks. Top holdings include Simon Property Group Inc. (SPG

Simon Property Group Inc
SPG
161.95
+0.36%) and Public Storage (PSA
Public Storage
PSA
200.34
-0.93%).

If you prefer a real estate mutual fund, Prudential Global Real Estate Fund (PURAX) is a global real estate fund. The fund is 97.5% invested in real estate. 52% of holdings are in North America, with the remainder invested in Europe (17% of holdings), and Asia (31% of holdings). This fund is primarily focused on developed markets, with less than 2% of funds invested in emerging markets.

The Bottom Line

Investing in individual properties requires a lot of capital and comes with a high risk. Investing in other options available through the stock market, REITs, mutual funds, and ETFs can give your portfolio real estate exposure without having to lay out hundreds of thousands of dollars.

As with any investment, investing in real estate and related companies comes with some risk. Evaluate any investment option before buying to ensure it lines up with your investment goals.

American and global real estate have performed well in recent years, but not all markets are alike. Some real estate exposure provides an excellent hedge against other market fluctuations, but too much real estate concentration leaves you open to losses when the real estate market falters, as it did in the recent real estate bubble burst and mortgage crisis.

However, once you have a good understanding of your investment goals and how real estate can play a part, you can confidently invest and make real estate a portion of your portfolio for both short-term and long-term investment goals.

Is Real Estate Your Retirement’s Secret Weapon?

[OPINION: The views expressed by Investopedia columnists are those of the author and do not necessarily reflect the views of the website.]

If you’re closing in on retirement, trying to put your money to work in a zero interest rate world is not an easy job. Financial writers and gurus are obsessed with the stock and bond markets. But despite the lack of attention, many Americans have fallen in love with real estate as an investment option

  • 28 million Americans are real estate investors (according to data shared by Landlordstation.com in 2013)
  • 35% of Americans now believe real estate is the best long-term investment (Gallup), compared to 32% who favor stocks
  • Stock ownership is at a low point: Just over 50% of Americans have money invested in the stock market (Gallup)

Americans may believe in real estate, but they don’t necessarily do anything about it when it comes to retirement. Real estate plays only a minor role in most people’s retirement portfolios, according to USA Today, and there are three good reasons.

  1. Liquidity. Stocks and bonds are much easier to buy and sell.
  2. Fear of bubbles. Many investors (and homeowners too) were traumatized by the credit crisis of 2008 and 2009 when the U.S. housing bubble burst.
  3. Too complicated. Investing in real estate can seem very complex because there are multiple ways to own real estate.

Most financial advisors lean heavily on the stock market for retirement for these reasons. Then there’s the not unimportant fact that stock investors have seen massive gains over the past five years.

The issue is what will happen in the next five years and beyond. There are now big questions about how long the bull market will last, and fixed-income investments are paying less and less. All are good reasons to consider what role real estate could play in your retirement portfolio.

Just like any other investment, it’s essential to set realistic expectations from the get-go. But deciding what to do next is complicated. Where should you start?

Options in Real Estate

Aside from owning your own home and counting it as part of your retirement savings, these are some of the most popular ways to invest in real estate either directly or indirectly:

Direct ownership:

  • Flipping houses (buying fixer uppers to repair or update and sell at a profit)
  • Owning apartment buildings or houses to rent out (you can also own these in a self-directed IRA, if you follow certain rules – see House Your Retirement with Self-Directed Real Estate IRAs).
  • Directly owning commercial real estate and renting to business tenants

Indirect ownership:

  • Holding shares in a real estate investment trust (REIT) or through mutual fund (see 5 Types of REITS and How to Invest in Them)
  • Holding a stake in real estate through a partnership (read up on this in How to Invest in Private Equity Real Estate)
  • Owning publicly-traded or privately-held debt on real estate
  • AAA-rated commercial mortgage-backed bonds

Any of these options, especially bonds that package up loans on commercial properties, can make your head spin. Investopedia’s tutorial Exploring Real Estate Investments can help you get a more detailed sense of what’s involved.

Real Estate Returns

Then there’s the question of how much of your money should go in the real estate bucket. There’s no simple one-size-fits-all answer, but advisors across the board agree that investing 5% to 10% of your retirement savings is a sound strategy. They also say to go in expecting that long-term annual returns on any real estate investment should average 3% to 6% a year. The more real estate you own directly, the higher your risk for losing money – and the bigger your potential for making more.

Seasoned owners of rental properties typically look for annual returns on their original investment to be in the 5% to 10% range after all expenses are paid. Indirect investments in, say, publicly traded REITs or real estate mutual funds act more like the stock market with returns on REITs ranging from 27.5% in a bumper-crop year (2014) to 7.5% over ten years, according to REIT.com. Returns over the last 25 years were 10.6%, while 40-year returns averaged 12.83%. In many cases, according to the website’s study, REITs outperformed large-cap U.S. stocks. For example, large-cap growth stocks returned only 13.69% in 2014 and 9.62% over 25 years.

Taking the Hands-on Approach

If the idea of being a landlord and collecting rent checks sounds appealing, think carefully about how much time, sweat equity and effort you really want to put into this investment. Plenty of everyday people generate steady, predictable cash flows by owning rentals and you could be one of them. Since real estate values depend mostly on location, how much you can make by investing in a rental property depends on where and how you invest, including how much you borrow and pay for financing.

Playing landlord means making sure your tenants pay their rent on time, evicting them if they don’t, handling repairs and maintenance on the property, and who knows what else (see The Complete Guide to Becoming a Landlord). Owning an income property is different from other investments because it requires much more active involvement even when you hire a property manager to oversee it.

Before moving ahead, here are what the pros recommend for first-time investors:

  • Find a rental property that’s in a high-demand area to avoid a long-term vacancy
  • Negotiate a purchase price that’s below the current market value
  • Make a down payment of at least 20%
  • Set aside plenty of cash reserves to cover all expenses

Next Steps

Real estate as the centerpiece investment for retirement isn’t for everyone, but if your goal is to generate more retirement income, adding some real estate exposure in your portfolio can make sense. It doesn’t have to be a question of the stock market versus real estate. You can have both.

How much exposure is a question you can talk through with an experienced financial advisor who has real-world real estate knowledge and practices as a fiduciary. He or she can help you come up with a real estate strategy that works for your specific situation.