When it comes to deciding where to invest your savings, the debate often boils down to property versus shares. Each has its loyal supporters, and the pros and cons of both have fueled debates for decades. Understanding the key differences can help you make an informed decision that aligns with your financial goals.
The Fundamentals: Shares vs. Property
Investing in shares and property involves unique considerations, from costs to liquidity. Real estate typically comes with higher upfront costs, such as stamp duty, legal fees, and other expenses that can significantly inflate the purchase price. Holding costs like property management fees, maintenance, rates, and insurance also add up over time.
Shares, on the other hand, are less cumbersome. Transaction costs are lower, and there are no ongoing maintenance fees. Liquidity is another advantage. You can sell shares partially or entirely and have the cash in your account within days. Selling property, however, can take months, and you can’t offload a part of it to meet short-term needs.
Harnessing the Power of Compounding
One of the most powerful tools in investing is compounding—earning returns on your returns over time. Shares, particularly those that pay dividends, are ideal for compounding. Reinvesting dividends allows your portfolio to grow exponentially.
For example, an investment of $100,000 in the Vanguard Australian Shares ETF in 2014 would have grown to approximately $246,000 by 2024 if dividends were reinvested. Similarly, a comparable investment in an ETF tracking the S&P 500 could have grown to over $521,000 with reinvested dividends, showcasing the long-term potential of share portfolios.
Property, while capable of appreciating in value, lacks this reinvestment mechanism. Rental income can pay down debt or fund improvements, but these actions don’t guarantee enhanced returns in the same way dividend reinvestment does.
Tax Advantages: A Key Consideration
Tax benefits differ significantly between property and shares. Negative gearing is a well-known perk for property investors, allowing you to deduct certain holding costs from your taxable income. However, as loans are repaid, this benefit diminishes.
Shares also offer tax advantages. Loans used to invest in shares, such as margin loans, often qualify for interest deductions. Additionally, Australian shares provide franking credits, which can reduce your overall tax liability. For instance, franking credits added an average of 1.5% annually to the Vanguard Australian Shares ETF returns, boosting its total return to 10.1% per year over the past decade.
Risk and Diversification
Property investments tend to be concentrated in a single asset, making them susceptible to location or market-specific risks. A downturn in the local real estate market can significantly impact your investment.
Shares offer an unparalleled opportunity for diversification. Through ETFs or direct investments, you can spread your funds across industries, markets, or even geographies. The ability to buy into various sectors, such as technology, healthcare, or real estate, allows you to manage risk more effectively.
Gearing: Boosting Returns with Borrowing
Both shares and property can benefit from leverage. For instance, a $1 million property purchased with an 80% loan ($200,000 equity) and appreciating at 6.4% annually would grow the owner’s equity to $1.06 million over 10 years, an annual return of 18.1%.
A similar effect can be achieved with a geared share portfolio. Borrowing $100,000 against a $200,000 investment in a balanced ETF portfolio (50% Australian shares, 50% international shares) could yield a 17.3% annual return over a decade. Increasing the gearing to 50% could push the equity return to over 20% per year.
Volatility and Liquidity
Share markets are more volatile than property, largely due to their liquidity. Prices fluctuate in real-time, making it easy to react emotionally to market dips. Property values, though equally susceptible to changes, are masked by their illiquidity, as valuations occur less frequently.
While volatility in shares can be unsettling, it also presents opportunities for disciplined investors to buy during dips. Property, on the other hand, requires patience and a long-term view, as it’s harder to act quickly in response to market changes.
Market Reactions: Flexibility vs. Rigidity
A crucial distinction between shares and property is how quickly and effectively you can react to market changes. Shares, being highly liquid, allow investors to respond to shifts in the market almost instantly. If there’s a sudden economic downturn or a sector-specific issue, you can sell part or all of your share portfolio and have the cash in your account within a few days. This flexibility enables you to adjust your strategy swiftly, either to mitigate losses or to take advantage of new opportunities.
Property, on the other hand, is inherently illiquid. If the property market experiences a downturn, your options are limited. Selling real estate can take months due to the lengthy processes of finding a buyer, negotiating, and completing legal transactions. During this time, market conditions could worsen, potentially eroding more of your property’s value. Moreover, property owners cannot sell a portion of their investment to free up cash, unlike shareholders who can liquidate part of their portfolio as needed.
This difference in liquidity means that shares offer more agility in responding to market trends, while property requires a longer-term commitment and resilience to market fluctuations. For investors who value the ability to adapt quickly, shares hold a clear advantage.
Choosing the Right Investment
Both shares and property have the potential to build wealth, but the right choice depends on your personal circumstances, risk tolerance, and financial goals. Shares offer liquidity, diversification, and tax efficiency, making them a compelling option for those seeking flexibility and compounding growth.
By understanding the unique benefits and challenges of each asset class, you can craft a portfolio that aligns with your financial ambitions and gives you confidence in your investment journey.
If you have questions on how to invest your wealth or specific advice, reach out to Cadre Capital Partners.
