Risk Is A 4 Letter Word

If I were to ask you which investment is more risky; real estate or stock market, which would you say? The majority of people I have spoken to over the years say the stock market is more risky. No doubt this is due to a general lack of experience or knowledge of the stock market, while nearly everyone has experience with real estate (either by owning or renting). The truth of the matter is, from an investment stand point, real estate is a much more risky investment than the stock market.

One of the biggest measures of risk is liquidity – how fast can you turn the investment into cash. If you need cash now, can you dump that house overnight? Chances are the answer is no (not without a big discount anyway). On the other hand, I can log on to my TD Waterhouse account, and with a click of the mouse, issue a market sell order on my stocks and those stocks will be gone in less than 30 seconds. The lack of liquidity is the main reason real estate is a higher risk investment. The other one is performance.

Historically, real estate returns are not as high as the stock market. Sure there are times when things go crazy, like right now, but on average real estate goes up at the rate of inflation. Also, when there’s a real estate crash, it can last a long time.

Average condo price in Vancouver

If you brought a condo in 1990, you didn’t recover your investment until 2004. That’s 14 years! By comparison if you take any five year points on the S&P 500 index, you’ll see that the end point is always higher than the start point. This is why you always hear financial planners say you should invest for at least 5 years. However, this 5 year strategy doesn’t apply to real estate.

Real estate’s main advantage over the stock market is leverage. And we all know that leverage is the key to building wealth. While you can set up a margin account to buy stocks with borrowed money, the most a broker will lend on such an account would be 50%. By comparison, banks will lend up to 95% on a house. That means you don’t need the investment to do well to get a great return. If you borrow $95,000 to buy a $100,000 house, the house only needs to go up by 5% for you to double your double your money. However, the tremendous leverage available also makes real estate riskier. Should the price of the house drop 5%, you just lost all your money.

There are ways to take advantage of the leveragability of real estate with the lower risk of the stock market. The best is the home equity line of credit and systematic withdrawal plan. With that strategy, you are putting your house to work in an investment that has historically out performed the real estate market, yet you are not putting up any of your own cash to buy the stocks.

When people talk of risk the phase “The higher the risk, the higher the reward” often comes up. Unfortunately, that is a misquote – the real quote is the higher the risk, the higher the POTENTIAL reward. Wealth is built more on the management of risk than it is on the return on investment. Learn to manage risk and the return will pretty much take care of itself.

5 thoughts on “Risk Is A 4 Letter Word”

  1. Marco says:

    Real estate’s main advantage over the stock market is leverage.

    I disagree. The main advantage (in Australia) is taxation. You get can set it up so you can rent out your investment property and negatively gear it. (Which isn’t so good) Or positively gear it and claim the cost of maintenance and repairs as a tax deduction. In Australia we also given free money – called the “First Home Owner Grant”.

    Leverage is availed in the stockmarkets through margin loans, the use of equity from your property and through the use of derivatives like options (too complicated to summarise in a sentence, but basically a contract for a right to buy or sell a stock at a certain time), warrants (buying a structured product from a market maker which instills an interest component in the product) and CFDs (Where you trade on margin and can possibly “borrow” $1,000,000 from $10,000 but very risky).

    Learn to manage risk and the return will pretty much take care of itself.

    I agree… much of stock market trading is also about managing risk.

  2. John Chow says:

    The tax advantage of real estate investing isn’t as great in Canada. While the primary house is not subject to any capital gains tax, an investment property is. You can deduct carrying charges, maintenance and repairs. However, there is no such thing as a first owner grant for investment real estate.

    The higher maintenance and upkeep is another reason real estate is more risky than stocks. Stocks can be pretty much hands off but real estate is as hands on as you can get.

    Ah derivatives. Those were fun days. I would do a blog post about it but I fear my readers would get a head ache trying to understand it.

  3. Alex says:

    Hi John.

    I don’t think you truly appreciate the risk/reward characteristics of the equities market. The stockmarket has always been home to alot less risk averse participants, because all those participants understand one important historical characteristic of stocks: They have much higher returns (compared with real estate), because they require you to take on alot more risk.

    Being a currency trader myself, I rarely dabble in the equities market or the derivatives of them. However, when I first got started, I was primarily involved in equities, options and warrants, and so have a broad understanding of all investment vehicles and their associated risks.

    Furthermore, liquidity is an important measure of risk, but definately does not rank as high as you put it (especially from an investment stand point, as you put it). The most important measure of risk is the historic volatility of the security your are investing in, and by all accounts, the safest vehicle an investor can drive is definately real estate.

    On a side note I enjoy reading your blog, this was a rare bump in the road for you.

  4. Edward Heming says:


    Great comment. Volatility is definately a very important variable in assessing any market.

    What makes me particularly interested in the upcoming housing crash is that the nature of the housing market has irrevocably changed in the past 5-7 years.

    This change is not unlike the changes in the cash currencies markets between 1999 and 2000 (when electronic access to these markets altered many of their characteristics).

    The primary reason for this change in the housing market is higher leverage. Before 1990 it was extremely rare for you to be able to get a home loan for less than a 20% down payment. Before 1995 zero down and adjustable rate mortgages were not widely available. Although many economists have argued that adjustable rate mortgages are a small minority of the total mortgages, I would argue that this group could still have an impact.

    All it would take would be a shakeup in the housing market (at least here in Southern California) to start the slide. In fact, the current downturn in the construction industry (due to fewer home starts) and the mortgage lending industry (who coincidentally utilize 70% of all office space in Orange County) could cause enough people to be laid off or “right sized” to cause a wave of foreclosures. This wave of foreclosures could hurt the above industries further causing a synergistic feedback cycle that would erode housing prices while devestating the economy.

    This isn’t as farfetched as it sounds, especially in light of the all time household debt and country wide debt levels. As I’m sure you know as a fellow currency trader, if the Chinese (and Asia in general) were to lose confidence in the U.S. dollar and start selling U.S. Treasuries it could definately have a serious impact on the U.S. economy and housing prices.

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