{"id":2727,"date":"2022-06-03T05:11:16","date_gmt":"2022-06-03T05:11:16","guid":{"rendered":"https:\/\/royabhishek.in\/urbanbuyer\/property-versus-shares-a-practical-comparison\/"},"modified":"2022-06-03T05:11:16","modified_gmt":"2022-06-03T05:11:16","slug":"property-versus-shares-a-practical-comparison","status":"publish","type":"post","link":"https:\/\/royabhishek.in\/urbanbuyer\/property-versus-shares-a-practical-comparison\/","title":{"rendered":"Property versus Shares: a practical comparison"},"content":{"rendered":"

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As a completely independent advisor, I have no vested interest in how my clients invest.<\/strong><\/p>\n

\"SWhether they invest in property, shares, or any other asset class makes no difference to my life.<\/p>\n

Of course, I want them to invest in<\/p>\n

    \n
  1. assets that are most appropriate for them and<\/li>\n
  2. assets that provide the highest returns without taking an unacceptably high risk.<\/li>\n<\/ol>\n

    I know that if I help my clients invest successfully, they will continue to remain clients, and therein lies my firm\u2019s success.<\/p>\n

    Often investors contemplate (and compare) investing in either property or shares.<\/p>\n

    The property\u00a0versus<\/em>\u00a0shares debate is meaningless<\/span><\/h2>\n

    It is often debated which asset class is better, property or shares. <\/p>\n

    I view this debate as arguing which golf club is best.<\/p>\n

    Each club has its unique purpose, and the reality is that golfers need many clubs in their bags to play well.<\/p>\n

    Investing is no different. Investing in a mixture of asset classes allows you to balance out the pros and cons of each asset class at a portfolio level.<\/p>\n

    Ignoring any one asset class in totality gives rise to higher investment risk as you are putting too many eggs in one basket.<\/p>\n

    In summary, I think shares and property are equally good asset classes.<\/p>\n

    I believe that most investors should invest in both.<\/p>\n

    I believe that if you employ an evidence-based approach, in the long run, the investment returns produced by property and shares should be materially similar.<\/p>\n

    The big difference is an investors\u2019 appetite for gearing<\/span><\/h2>\n

    Most people feel more comfortable borrowing to invest in property but less so with shares.<\/p>\n

    There is a good reason for that.<\/p>\n

    The chart below is from my book,\u00a0Investopoly<\/em><\/a>.<\/p>\n

    It sets out the long-term returns and corresponding volatility of each asset class.<\/p>\n

    \"Chart1<\/a><\/p>\n

    The average volatility rate (or standard deviation) for shares is 20.9% and the average long-term return is 11.6% p.a.<\/p>\n

    To put this in non-mathematical terms, two-thirds of the time, you can expect your annual return from shares to be in the range of -9.3% and 32.5% (being plus or minus one standard deviation from the average).<\/p>\n

    And 95% of the time your return will be between -30% and 53% (plus or minus two standard deviations).<\/p>\n

    That is a very wide range, right?<\/p>\n

    \"Volatility\"And that is why shares are seen as volatile, as the return can vary significantly from year to year.<\/p>\n

    However, residential property is a lot less volatile.<\/p>\n

    Two-thirds of the time your return will range between 0% and 20%.<\/p>\n

    And 95% of the time, between -10% and 30%.<\/p>\n

    Whilst this is still a wide range, it\u2019s a lot tighter than shares.<\/p>\n

    That is why people feel more comfortable borrowing to invest in property because the likelihood of experiencing a loss year (just after you have borrowed to invest) is relatively low (i.e. there were only 6 loss years between 1980 and 2016).<\/p>\n

    How to borrow to invest in shares<\/span><\/h2>\n

    I would almost never recommend someone borrow a large lump sum of money and invest it in shares in one tranche, for the reasons described above i.e. volatility.<\/p>\n

    Instead, I would usually recommend investing in a series of regular and relatively small tranches over (hopefully) many years.<\/p>\n

    Doing so helps you spread your market timing risk.<\/p>\n

    \"BorrowingThis can be a very effective strategy as explained in\u00a0this video<\/a>\u00a0by\u00a0Vanguard<\/em>\u00a0(watch from 1:30min).<\/p>\n

    \n

    This example shows that if you invested $500 per month in an Australian index fund beginning in 1990, by June 2020 your investment would be worth $760,000.<\/p>\n

    This balance comprises $177,000 of your contributions plus $583,000 of investment earnings.<\/p>\n

    It shows that the strategy of making regular investments over long periods of time (30 years in this case) creates significant value.<\/p>\n

    All you need is the discipline to stick with it and patience.<\/p>\n

    Therefore, I would typically advise an investor wanting to borrow to invest in shares to do so on a regular basis, not in one lump sum.<\/p>\n

    Shares\u00a0versus<\/em>\u00a0property: a practical comparison<\/span><\/h2>\n

    I would like to compare two scenarios:<\/p>\n

      \n
    1. Establish a loan against the equity in your home and draw $5,500 per month to invest in shares for 15 years i.e. $1 million invested; versus<\/li>\n
    2. Borrowing $1 million today to invest in property.<\/li>\n<\/ol>\n

      Shares scenario<\/span><\/h2>\n

      \"Mortgage\"I have assumed a total investment return of 9.8% p.a., comprising of 3.7% of growth and 6.1% of income (this is based on the past 10-year performance of Vanguard\u2019s growth index fund<\/a>).<\/p>\n

      Other assumptions include a mortgage interest rate of 6.5% p.a., a marginal tax rate of 39%, and that the investor makes a cash contribution into shares equal to the investment property\u2019s holding costs (i.e. the next scenario below).<\/p>\n

      Property scenario<\/span><\/h2>\n

      The investor purchases a house in Brisbane for $940,000 and borrows $1 million to pay for stamp duty and buyers\u2019 agent fees.<\/p>\n

      The property generates an initial rental yield of 3.2% and this rental income increases at a rate of 5% p.a.<\/p>\n

      The assumed long-term capital growth rate is 6.6% p.a. (so that the total return is 9.8% p.a. \u2013 same as shares).<\/p>\n

      The interest rate and tax assumptions are identical to the shares scenario.<\/p>\n

      And the winner is\u2026<\/span><\/h2>\n

      The chart below compares the value of equity for both scenarios.<\/p>\n

      It is obvious that property is the clear winner.<\/p>\n

      That is not because the property is \u201cbetter\u201d per se, but simply because the $1 million of borrowed funds were invested in full from day one (compared to $1 million invested gradually over the first 15 years).<\/p>\n

      \"Chart2<\/a><\/p>\n

      What is the property capital growth breakeven rate?<\/span><\/h2>\n

      \"PriceThe mathematical power of gearing can compensate for (or mask) poor investment returns.<\/p>\n

      The property strategy analysed above will be superior as long as the property\u2019s average capital growth rate exceeds 5.85% p.a.<\/p>\n

      This means that it is possible that investing in a property that is sub-investment-grade could still work out to be a superior strategy.<\/p>\n

      Of course, I would never endorse investing in a property that is not investment-grade.<\/p>\n

      My point is to not underestimate the\u00a0power of gearing.<\/p>\n

      The comparison is not fair, but it\u2019s realistic and practical<\/span><\/h2>\n

      As I have stated, the above comparisons have very different gearing levels, so of course, the scenario with a higher level of gearing produces superior results.<\/p>\n

      But we must not ignore the fact that gearing increases your investment risks as you have a larger interest rate exposure.<\/p>\n

      That is, you have an obligation to meet a property\u2019s holding costs (from your salary or other resources), whereas the share strategy is self-funding (investment income pays for the interest costs).<\/p>\n

      It is not always appropriate for people to gear to the high level that is necessary to invest in property.<\/p>\n

      This risk factor must be considered.<\/p>\n

      Property can be better, but only because of gearing<\/span><\/h2>\n

      The analysis above indicates that gearing into the property may allow you to accumulate 25% more equity over 30 years.<\/p>\n

      The property scenario above resulted in an equity value of $2.4 million in today\u2019s dollars ($5.06m in future value) versus $1.8 million for shares (future value of $3.81m).<\/p>\n

      Whilst the differential is material at $600,000 in today\u2019s dollars, considering that the shares strategy is self-funding, I\u2019d argue that both strategies produce relatively good outcomes.<\/p>\n

      It\u2019s probably more of a question of which strategy suits your circumstances and goals best, rather than which is the better asset class.<\/p>\n

      ALSO READ:<\/strong><\/span> Your Complete Guide to Property Investment<\/a><\/p>\n