Which is the better investment – shares or property? It’s the great debate that has fuelled many cocktail hour conversations.
One person usually kicks it off by maintaining that shares are the superior investment, citing an example such as $1,000 worth of Fortescue shares bought in 2001 would now be worth $685,000.
Of course, those on the pro-property side could easily maintain that if you buy the winning lottery ticket, then you can invest just $1 and end up a millionaire. However, if you buy property in a good location, you can't go wrong.
So, who is right and who is wrong in the property versus shares argument? You guessed it, both of them.
Using Fortescue as an example is just as ridiculous as using a person who bought a rundown shack out in the country only to find it was sitting on the world's largest oil deposit. Few people in 2001 – when Fortescue was trading for just 1 cent – could have foreseen that the company's owner, Andrew "Twiggy" Forrest would become one of the richest people in Australia.
A Vanguard investment booklet shows that, in the 20 years to 2006 (pre-GFC), Australian shares averaged a return of 11.9% per year. Similarly, an ASX report on property returns showed that Australian residential property increased at an average annual rate of around 12% per year (12.1%) for the same period.
Despite almost identical returns for stock and property markets it is far more common to run into someone who has made their fortune in property. Closer examination reveals why.
For example, let’s assume you have $100,000 to invest in either the stock market or property market. Using the 12% average rate of return, we can get an idea of how much you would make investing in shares:
- Year 1: $112,000
- Year 2: $125,440
- Year 3: $140,493
- Year 4: $157,352
- Year 5: $176,234
So, after five years of investing in the stock market, you have made more than $76,000 from the initial $100,000 investment.
Now let's look at what would have happened if you bought property. While $100,000 isn’t enough to buy something outright, it would make a nice down payment for a $500,000 home with a mortgage of 8% p.a.
Here we can see the magic of leverage at work:
- Year 1: 560,000
- Year 2: $627,000
- Year 3: $702,464
- Year 4: $786,760
- Year 5: $881,171
Let’s assume you took out an interest-only loan leaving the entire $400,000 to be paid off at the end of Year 5. When you add in almost $160,000 of mortgage payments made over the five-year period, you still end up with a return of more than $320,000 on your initial $100,000 investment.
So, it's not so much the investment vehicle that makes the difference but rather the leverage involved in investing. There is the argument that you could borrow to invest in shares but the difference is that, as long as you are keeping up your mortgage repayments, the bank won't come chasing after you if your property temporarily falls in value. The same can't be said if you borrow against equities.
This article is not intended to offer specific advice.
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