by Ernesto R. Martin

Someone in my family is a Chartered Financial Analyst (CFA, which is a big deal) and works as an analyst for an investment firm. He finds fault with my comparison for several reasons. First, he says that, because of liquidity, I'm comparing apples and oranges (i.e., you can sell stocks and get your money out in one day, while an apartment would take several months to sell). My response is that at the outset you're told that a stock investment is for the long term, with money you won't need for, say, 10 years. So, I think it's fair to compare stocks with other investments that are long-term, where liquidity isn't as important.

Second, he says that there is more downside risk in one apartment than there is in an investment across the 500 largest U.S. corporations. My response is simple: one, the well diversified Dow Jones Industrial Average index lost more than half its value (52% loss) from September 21, 2007 to March 6, 2009, and two, do you know anyone who has lost money on a properly selected residential property (e.g., not in a depressed area or a fire zone)? All you see in every residential property over the long term is gains. Also note that if the property vanishes (fire, earthquake), it's insured, and the payout is its then market value, not what you paid for it.

Finally, he argues that a major reason for the good returns shown here is the leverage afforded by the bank loan (i.e., that you only paid for 1/4 of the property but later enjoy the appreciation of the whole enchilada), and that a fair comparison should be against a leveraged purchase of S&P 500 stocks, where lenders typically require that the investor put 50% and the lender the other 50%, so there is less leverage. My first point is that serving the debt may be burdensome for someone just starting to invest; in the apartment case there is no average monthly out-of-pocket to service the debt, because the rental income covers it, but in an investment of $200,000 in an S&P 500 index fund, a 6% interest-only loan of $100,000 (to complement the $100,000 cash you're investing) requires a monthly payment of $500. Second, I haven't run the numbers but I would expect that, because of the smaller leverage, the returns would not be significantly superior to that of a simple investment of cash, without a loan, without leverage. In what I admit is a simplified approximation, one way to look at this purchase of $200,000 in stocks is that the half you paid with your $100,000 will have the normal annual returns of the S&P 500 (historically in the range of 6.1% to 9.7% with dividends reinvested) and the other half you bought with the $100,000 borrowed from the lender can't have that much higher return because the 6% interest you're paying is close to the historical return of the S&P 500.