How should I invest for the future? Property or Stocks and Shares – 4 Key Features of Each

Phil Hendry20/04/2021

DISCLAIMER TIME:

Ok, so let’s first acknowledge that there are significant shades of grey with this.
Particularly when it comes to which option provides the better return overall.
In fact, it can become so granular that you would never reach a conclusion anyway.
There will be instances where we would suggest favouring one over the other.

So instead, we’ll focus on what is constant.
What are the controllable factors.
The defining features of each which remain relevant regardless of anything else.

Because it’s a topic that comes up quite often with clients, asking us:
Should I invest in a pension? An ISA? Property?
And in reality, returns in a share portfolio don’t change just because it is in a pension, it’s the taxation of it that does.

board game

So what are the 4 key features which give weight to choosing one over the other?

Behavioural biases

Winner: Property

‘Investing’ as we know it in its current format is quite recent.
Unfortunately, our humans instincts are not!

This means we are actually ill-equipped to invest effectively.
This is due to our survival instincts and awareness of danger.
(Although today’s dangers might be losing money or getting scammed. Not so much getting attacked by a sabre tooth tiger or mammoth!)

The Three Factors

One significant bias we have where property is involved is something called ‘action bias.’
This is our preference to take action to ward off danger and take back control of any situation.
This emotional response 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, some stock indexes are at or near all-time highs.

However, it’s also likely that several 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. And as anyone who has sold or bought a property will tell you – they are 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.

The average holding period for a share is around six months, which is no doubt down to the ease of trading, and this is likely to continue to come down.
Compare that to holding periods for property – it is more likely to years, if not decades.

Another benefit to property is something called ‘familiarity bias‘.
This is our preference to invest in what we know or understand, and avoid the unfamiliar or complex.

Daytime television during lockdown turned a number of 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 developing countries for example, could provide excellent opportunities, but plays on our fear of the unknown.

The final one (although we could go on!) is ‘loss aversion‘.
We humans really don’t like 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 mentioned before, 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.
This is perfect as you have no idea if you have lost or made money from one year to the next on your property.

Shares, on the other hand, because they are bought and sold often, are valued by the second and can increase or decrease throughout the trading day.
This shows the true value at any time you want…but that is not necessarily a positive thing!

Tax

Winner: Stocks & Shares

The British love affair that is ‘Property’ has sadly began to work against first time buyers. Buy-to-let 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!
They have also placed 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 or ISAs, for example.
This gives stocks and shares the advantage as investors walk away with more.

Borrowing to Invest

Winner: Property

Please note that this isn’t an endorsement from us saying you should consider borrowing to invest.

But generally, banks are extremely comfortable lending people money against a property.
With buy-to-let properties, investors can deposit up to 20-25% of a property value to buy it. As long as they service the mortgage, they can enjoy 100% of the capital appreciation on the property.

Now, let’s say for example 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. Well, tell that to those of us who got a mortgage out in the 1980s, 1990s or even 2000s!

Banks also would not allow you to borrow to invest in the same way with shares.

Liquidity

Winner: Stocks & Shares

Liquidity?
What do we mean by this?
We mean how easy it is to turn your investment into cash, and in what proportion.

As we said earlier, it’s not particularly quick or simple to suddenly turn your property into cash.
If you need to sell a property at what is the wrong time, there is absolutely no guarantee you could sell it even if you wanted to.
This lack of flexibility is much more noticeable during the big life moments.
Needing a lump sum to help pay for a wedding or property for a child.
Winding down (for example, when you stop work).You may 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 taxes, where property doesn’t.

Overall…

So it’s a 2-2 tie!

The most likely lesson is that you really have to decide why you are saving, for what and when.
It also means that it is not an ‘either/or’ decision.
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!