Hopefully many of us will soon be making choices about what we will invest in. While we are still far from retirement, two asset classes are likely to dominate this choice – equities and property. These two classes are said to yield high returns that exceed inflation, making them the obvious choice over the more secure, but lower-yielding options, for investors with a long time-horizon. But of the two, which is more attractive?
By asking this question, I don’t mean to imply than only one should be chosen. It’s likely to be better to include both in your portfolio, so as to benefit from diversification. Nevertheless, I was interested to find out more about how these two classes compare, and what kinds of proportions each should constitute in a typical portfolio.
Joshua Kennon gives an answer that we should expect by now – it depends on the investor.
He goes on to list pros and cons of both asset classes that may have varying degrees of importance to different investors. Some of the points he makes should be familiar by now – e.g. equities are more liquid, but have greater short-term variability.
Interestingly, he mentions one of the advantages of investing in property to be that it is tangible. For some people, he says, being able to point at property and declare “I own that!” can be important psychologically. Our Act Ed notes also mention that property investments can result in extra utility to the investor. This will ring true to you if you know anyone who enjoys renovating, or who loves being able to say, “I built that!” Although these sorts of returns aren’t financial, they shouldn’t be ignored.
Another interesting point he makes is that it is more difficult to be defrauded when investing in property, since you can perform physical inspections. Given the number of stories I’ve heard of people who’ve uncovered undesirable features of properties only after renting or purchasing, I’m not sure how true this is, but it’s an interesting point nonetheless.
It’s not all good for property though. In his words, “buying stocks, reinvesting the dividends, and holding them for long periods of time has been the greatest wealth creator in the history of the world.” In contrast, in this article he argues that property values don’t even keep up with inflation. He does say that many investors are too emotional or undisciplined to take advantage of the high returns on equities, but the fact remains that higher returns are generally expected on shares than property. There are also higher management costs, and possibly even hands-on work required for property investments.
Despite this, property could be very appealing because it is generally much easier to use leverage to invest in property than other asset classes, as Ann Wilson points out. You can take out a mortgage to invest in property, but it is more difficult to borrow to invest in shares or other financial instruments. As a result of using leverage, the absolute amount earned on the investment can be larger for property even if the rate of the return on the investment is smaller.
An important consideration for property investment is that there may be periods where no rent is collected. In this article, a rule of thumb is suggested of never directly owning more property than you can maintain without receiving rental income, due to this risk.
Indirect investment in property does avoid some of the disadvantages that I’ve discussed here, but it is still recommended that the proportion of risky assets invested indirectly in property should not be too large, as the recent crisis showed that there is a large amount of undiversifiable risk in the property market.
Overall, I think that there are some great points in favour of both property and equities. That said, my view on this is that there may perhaps often be more room in a portfolio for equities, given the higher expected return, while property could be used for diversification benefits and to augment the portfolio by introducing leverage. Of course, this is all subject to the specific needs of the investor.