How should I invest for the future? Property or Stocks and Shares – 4 Key Features of Each
Ok so let me first acknowledge that there are significant shades of grey with this. Particularly when it comes to which stocks and shares, and which property i.e. which provides the better return.
This can become so granular that you would never reach a conclusion anyway, and different instances would suggest favouring one over the other. Instead, let’s focus on the constants / controllable, and the defining features of each which tend to remain relevant regardless of which particular share or property, at any particular time.
Given this is a topic that comes up quite regularly, people often say “pension / ISA or property?” The 4 key battlegrounds below remain the same. And in reality, returns of a share portfolio don’t change just because it is in a pension, it’s the taxation of it that does.
So what are the 4 key features which give weight to choosing one over the other:
Our behavioural biases (Property wins)
The advent of investing in its current format is really quite recent, unfortunately, our instincts as humans are not. This means we are actually ill-equipped to invest effectively. This is due to our survival instinct and awareness of danger. The danger in today’s format might be losing money, rather than being attacked by a sabre tooth tiger!
One significant bias we have which definitely lends itself to property is something called action bias, in short, this is our preference to take action to ward off danger and take back control of any situation. Sadly, however, quite often, this is the complete opposite of what we should do when it comes to stock markets. For example (at the time of writing), although we are still battling a global pandemic, a number of stock indexes are at or near all-time highs. However, it’s likely a number of investors sold off in March/April 2020 in a panic, and have yet to re-enter the markets. Property, on the other hand, works perfectly to counter this sort of self-defeating behaviour. With property sales being notoriously long and complex, you cannot just flippantly sell from one minute to the next which you can with stocks and shares. Sometimes you couldn’t sell a property even if you wanted to! This feature protects property investors from being their own worst enemy. Most recent studies suggest the average holding period for a share is 5 ½ months, which is no doubt down to the ease of trading, and this is likely to continue to come down. Holding periods for property on the other hand, are more often than not multiple years, if not decades.
Another bias that works in property’s favour is something called familiarity bias, which is essentially our preference to invest in the familiar / avoid the unfamiliar. With the majority of daytime television turning us into amateur property investors, and the fact a huge number of us have owned one or more properties in our life, investing in another property is a much easier leap. Investing in stocks and shares in China, for example, provide excellent opportunities, but plays against our fear of the unknown.
The final one (although I could go on!) is loss aversion. Its been shown that as humans we dislike losing, twice as much as we do winning. In other words, it feels twice as bad to lose some money on an investment, as it does to make money on an investment. Again, property works well with this. As touched upon already, when we buy property, we tend to hold onto it for longer. Because of this, you cannot be sure about the current value of a property, without putting it on the market. But from a behavioural perspective, this is perfect, as you have no idea if you have technically lost money from one year to the next on your property. So often this makes you feel as if property doesn’t fall in value when that’s not really the case, but this plays perfectly into our fear of any loss, even if it’s temporary. Shares, on the other hand, are valued by the second, because they are bought and sold that often, in substantial volumes. This shows the true value at any time you want…but that is not necessarily a positive thing!
Tax (Stocks and Shares Win)
Property has become such a British love affair that sadly this began to work against first time buyers. Quite often buy to let property investors favour smaller properties, as rental returns tend to be better. But this is usually the properties the first time buyers tend to go for to get onto the property ladder.
This has led to the government introducing measures to discourage property investors by making returns less appealing…particularly after tax. The government have introduced an additional tax on residential properties for buy-to-let investors when buying, renting out, and selling investment properties.
Stocks and shares, on the other hand, are favoured by the government for the most tax-advantaged tax vehicles…such as pensions, ISAs etc. This gives stocks and shares quite a leg up in terms of what investors ultimately walk away with.
Borrowing to Invest (Property Wins)
Now don’t take this as us advocating borrowing to invest, as this can easily work against you. But generally, banks are extremely comfortable lending people money against a property. With buy-to-let properties, this lets investors stump up say 20-25% of a property value to buy it, and as long as they service the mortgage, enjoy 100% of the capital appreciation on the property.
Now, let’s take an incredibly simple example, and let’s say you buy a £100,000 property, putting up £20,000 of your own money, with the bank coming up with the rest. Let’s say it increases in value by 10% in 2 years, this brings the property value up to £110,000. If we assume an interest rate of 2.5% p.a., you have spent £4,000 on interest. This leaves you with a £6,000 net gain.
Let’s take the same £20,000 you put into the property and assume you invest this in stocks and shares, also achieving a 10% return over 2 years. This leaves you with a £2,000 capital gain…£4,000 less.
This can obviously go wrong if interest rates rise. If the interest rate on the mortgage rose to 6.25% for example, the position becomes neutral. This would never happen I hear you say, tell that to those with mortgages in the 80s, 90s and 00s!
Banks would not allow you to borrow to invest in the same way with shares, characteristics of shares just do not lend themselves to that.
Liquidity (Shares Win)
What do we mean by this? Basically how easy it is to turn your investment into cash, and in what proportion.
As touched upon already, it’s not particularly quick or simple to suddenly turn your property into cash. If circumstances demand it, and you need to sell a property at the wrong time, there is absolutely no guarantee you could sell it even if you wanted to. This lack of flexibility does not lend itself to stages in life where you need this, such as needing a lump sum to help pay for a wedding or property for a child. Or when you are decumulating (when you stop working for example) and will likely need to take more on an ongoing basis from your investment than the rental income you receive.
The flexibility also feeds into the other trump card for shares, taxes. The ability to buy, sell and transfer shares in small proportions allows far more scope to plan against a number of taxes, where property doesn’t.
So it’s a 2-2 tie! The lesson is most likely that you really have to come back to why you are saving, and for when. It also demonstrates that it is not a binary choice, to go all-in on property or stocks and shares. Each of these features will lend themselves to different goals, so start with those first!