How does investing work? – Property / Shares

Property

We all love property. We all want to buy property. Whether we can afford to buy it is another question, but we all talk about house prices. Particularly for Baby Boomers, property has turned out to be a good investment. House price data from the Australian Bureau of Statistics supports this view. If you bought an average house in Sydney 40 years ago, you’d have paid $50,700. Today, you could sell it for $875,000. That’s an overall increase of 1,626%. Amazing, right? Not quite.

It actually equates to an average growth rate of just 7.38%.

So how did everyone make money?

Debt. Nearly every homeowner loaded up on it.

In financial industry parlance, it’s called leverage. You buy a house for $100,000, you pay a 20% deposit ($20,000) you borrow the remainder $80,000. The house price rises by 50% to $150,000. But your return is not 50%, it’s 250% on the amount you invested. This is because your $20,000 investment has increased to $50,000. Not taking into account how much extra you have paid off the loan.

We’re often lectured about the evils of borrowing (rightly so when it’s excessive) but a little bit of sensible borrowing has its merits. Of course, the caveat to this is that while leverage can amplify returns when house prices go up, the reverse is also true if house prices go down. It is important to remember that all investments carry risks and that the value of investments and the income from them may go down as well as up and you may not get back the amounts originally invested.

Shares

The perfect advocate for stock market investing is billionaire Warren Buffett. One of the world’s richest men, he initially built a fortune by fastidiously buying shares he believed were unfairly undervalued. According to Business Insider, he achieved a return of 24.5% a year, after fees, between 1957 and 1969 compared to only 7.4% a year for the Dow Jones stock market index. Today he’s number three on the Forbes Rich List, worth $86bn.

Extraordinary periods of returns may be just that – unusual one-offs. Mr Buffett had a pragmatic approach in 1967 when he said: “The results of the first ten years have absolutely no chance of being duplicated or even remotely approximated during the next decade.”

That’s a healthy, sceptical investment attitude.

Buffett’s success is one thing. Looking more broadly, you can analyse other data. The Credit Suisse Global Investment Returns Yearbook suggests stock market returns were 5.1% a year, with inflation taken into account, between 1900 and 2016. In the golden era, from 1980 to 1999, the annual return was 10.6%. This may sound modest against the property price gains - but the house price numbers did not take into account inflation. Official data shows the average Australian inflation rate for the last 40 years has been approximately 4% per year. So, a 7% annual gain is reduced to approximately 3% after inflation.

How can I decide where to invest?

What we can say is that you shouldn’t put all your eggs in one basket. Financial advisers often suggest having some money in cash for emergencies (the advice tends to range from three months worth of salary to one year) and some money invested in the stock or bond markets. It is also fairly easy to invest in commercial property through the markets (without the need for a mortgage deposit)!

Remember past performance is not an indicator of future performance – both in the share and property market. It’s always a good idea to talk to a financial adviser before deciding what’s right for you.

(Article provided by Schroders)