The UK is obsessed with property investing and the property market, but not the stock market. The stock market is generally thought to be high-risk, confusing, and no place for the inexperienced. But is that fair?
On the face of it, a preference for property seems obvious. The reasons I hear most often are that:
- Property is simple – You can kick a house; it’s real, it’s tangible, and everybody understands property
- It’s low risk – A house isn’t going anywhere, is insured if it burns down, and people will always need houses
- It’s a high-return investment – Prices may go down in the short term, but in the long run they always go up by more than inflation
On the other hand, the stock market is often seen as being the complete opposite:
- It’s mysterious – You can’t touch a share, you don’t know what companies are really doing, and shares go up and down with no rhyme or reason
- It’s high risk – It’s volatile, has frequent booms and crashes, can drop by 50% in a year or two, many companies go bust, and you can lose all your money
- Returns are uncertain – We’re still below the peak from the year 2000, and stock markets can go nowhere for decades
But if you dig a little deeper, it turns out that these differences are not as real as they seem. Here are my three reasons why property investors should consider the stock market:
Reason 1 – Stock market investments are every bit as real as property investments
The stock market is not as mysterious as some people think. If you “look through” the stock market, what do you actually have? You have investors, and you have businesses. Stock market investors are actually business investors, which in many ways is not that different to being a property investor.
You might want to try this: Drive down to your local Tesco. Can you kick it? Yes, you can. If you decide to kick it, then you will have kicked a stock market investment, and that’s my point.
“Stocks and shares” are irrelevant; what matters are the individual businesses that you can invest in and the price that you’re willing to pay.
You might also say that nobody really understands big business; they’re too complex, and that’s probably true. But I think I have about as much understanding of the FTSE 100 as I do of how a house works.
For example, I do not know the names of all 100 companies in the FTSE 100, but neither do I know the depth or density of the foundations of my house.
This lack of knowledge does not bother me because neither piece of information has anything to do with the returns that these investments will produce.
However, I do know how much profit the FTSE 100 generates and what dividend it pays. I also know how these have grown over the last decade or two. And I know that, just like my house, the FTSE 100 will probably be around much longer than I will.
In both cases, I have real, tangible assets (a house and a collection of 100 multi-billion pound companies) which are likely to generate growing incomes in the future and whose capital values are likely to go up, in the long run, faster than inflation.
I will admit that there is less uncertainty around a house than there is with the FTSE 100, and even more so with the 100 companies within it, but that’s okay. It’s much easier to diversify in the stock market than it is to diversify in the property market.
I can easily spread my money across 100 companies by buying the FTSE 100. Or, if I want to own company shares directly, it is still easy to invest in perhaps 30 companies. That massively reduces the uncertainty I would face from any one company.
And don’t forget, anybody who has been involved in property investing knows that it is not without its own level of uncertainty, with void periods, problem tenants and so on.
Reason 2 – Investing in the stock market is low risk compared to property investing
Now this really does seem counterintuitive. House prices don’t go down by 40 or 50 percent in a couple of years like the stock market so often does.
But to compare apples with apples, you have to remember that property is a geared investment; in other words, you borrow to buy the house. So let’s compare a property investment where you have put down a generous 25% deposit.
Imagine that you bought a house for £100,000 (it’s a small house) in late 2007.
Its price moves in line with the average house price in the UK. By early 2009, in the depths of the credit crunch, the market value of that house had dropped by 18.7% (in line with the UK market as a whole, according to figures from Nationwide), which is a loss in value of £18,700.
Remember that your investment was £25,000, so an £18,700 drop is actually a 74.8% loss relative to the amount you invested.
That’s far bigger than the 48% loss suffered by the FTSE 100 at the same time. Let me say that again:
Between 2007 and 2009, a conservative property investment using a 25% deposit lost almost 75% of its value compared to a 48% loss in the stock market.
Property investments are typically far more risky than stock market investments. You have to remember to look at the value of your equity in a property rather than the total value of that property.
Higher risk isn’t necessarily a bad thing, as the borrowed money allows you to invest more for much higher overall returns, but it’s important to understand the facts.
Property is a high-risk investment, with potentially massive rewards if you stick with it for the long term but potentially devastating losses if you can’t.
What most property investors will say, quite rightly, is that even if the price of a property falls, you don’t have to sell.
As long as you invest wisely and have a cash-flow-positive property, you can just sit there, collect your net cash income every month, and forget about falling property values.
In a few years, the property market will likely recover, and your property’s value will march upwards once more. That’s true, but once again, the same thing is true of the stock market.
If property investors can ride out falling prices by ignoring the market and collecting an income, then so can stock market investors. There is absolutely no difference.
- If property prices fall, so what? Collect your rental income and buy more property while prices are low and rental yields are high.
- If the stock market falls, so what? Collect your dividends and buy businesses while prices are low and dividend and earnings yields are high.
Reason 3 – In the long run the stock market is just as likely to go up as property
I’m sure that after the last few years, most people now realise that property prices go down as well as up, just like the stock market. And as I noted above, most property investments are more risky and more volatile than the stock market, despite what everybody thinks.
But for sensible investors, it isn’t short-term volatility that matters, it’s the long-term, and most people think that property will do much better in the long term than the stock market.
But history does not bear this out.
If you invest over a multi-decade period, you’re likely to get inflation-beating returns from both income and capital gains, whether you invest in the property market or the stock market.
That’s what happened in most parts of the world over the last century, and it’s reasonable to expect that it will be the story of the future too.
In fact, without gearing, the stock market generally performs better in the long run than property, but with the advantage of borrowed money, property does better if you can live with the hassle and risks involved.
Over the long run, the stock market and the property market have both proven themselves as sound investments for those who invest wisely in good assets at low prices.
The fact that the FTSE 100 is still below its year 2000 high is irrelevant. That just shows how ridiculously overvalued some businesses were at the time.
If, instead of investing in the FTSE 100, you spent the first year of this millennium buying high-quality businesses at a discount to their intrinsic value and avoiding insanely overpriced dot-com businesses, then your portfolio today could easily be more than double what it was back then.
The property market and the stock market are more similar than most people think
Fundamentally, property investing and stock market investing (or business investing as it should really be called) are not so very different.
While the details may differ, the same timeless principles remain:
- Buy good quality assets at low prices
- Hold them for a number of years and receive a good income
- Be willing to sell if the price is right
A few comments:
Most property investors would talk about there investment in terms of leverage and the advantages that offers, however you did so in a very negative manor highlighting a 74% loss.
Most property investors I know would just play the long game and while prices are low collect the cash flow positive rent.
While prices are low, buy another property with greater rental yield.
It could be argued property investors can add value quickly to a property via renovation or even buying at a below market price, which is possible.
A property investment is less liquid, therefore investors are more likely to hold on to it, compared to stocks and shares where some investors panic sell or over trade.
I looked at property in terms of renting, but it appeared too much work in comparison with shares, and risky in terms of terms of tennant problems. It’s like buying a job, especially if you expand and buy 4 £100k properties with £25 deposits compared to £100k in shares. Also at the mercy of interest rates.
(Written on phone so hope makes sense)
Hi Spurs fan, yes makes perfect sense. Gearing goes both ways I’m afraid – good on the upside, bad on the downside! Your point about work is an important one. It’s probably the biggest difference in that I can run a portfolio of 30 companies in just a few hours each month, but a reasonably diverse property portfolio is likely to be that much and more each week.
There is more money to be made in property, but it’s more work and much riskier, so ultimately it’s a case of each to his own, but it’s best to really understand the asset class before deciding to invest or not.
And of course you can easily structure many stock market investments tax efficiently and can convert back to cash almost instantly.
Hi Colin, yes but unfortunately I think the ability to sell instantly is probably a liability for stock market investors. If markets were less liquid I think investors would make more money by making fewer mistakes and thinking that little bit harder before investing their hard earned money.
I used to live in Canada and over there everyone goes on non stop about the stock market, not housing. They have whole channels and newspapers devoted to value investing, technical analysis and the like (see http://www.bnn.ca for example). Its got so frothy that right now I am selling my portfolio there and buying in the UK, because valuations are much better here. Why pay over 20 times forward earnings for utilities in a rising interest rate environment when I can get centrica or SSE for less. UK stock market investing is a hidden gem in my view.
As for the general point, housing can give you greater leverage, but then you can always buy a leveraged REIT if that is the objection. Without the diversification of a portfolio approach, I would describe buying a house as a highly leveraged bet on a single example of a single asset class in a single location. So its a high risk game. People, especially in the SE have yet to experience a housing crash of the kind visited on many US cities, so they still regard housing as a safe bet. I don’t think it is.
Hi Andrew, it’s interesting how different countries can focus on different asset classes. I guess it’s a mix of cultural and historical quirks, like the US fear of deflation and the German fear of inflation. I agree with your second paragraph – stocks and property are both fine investments when done with eyes open, but over here the risks of the stock market are definitely overplayed relative to property.
But then again, in the dot-com boom everybody seemed to think the stock market was a risk-free way to make money, so perhaps that attitude will become the norm again, once we’ve had multi-year bull market in stocks with property stuck in the doldrums…
The other big difference is in the size of a portion. If you in equities and need cash you can always sell a few shares……even if the market is down that is not a disaster. You cannot sell a bit of a house and you may be forced into a large liquidation at the wrong time.
Hi Paul. Unfortunately “If you’re in equities and need cash” is actually part of the problem. Investors shouldn’t really have money in equities if there is any chance that they’ll need the money back in cash earlier than they expected.
If there is any chance the the money will be needed then it should be in a cash ISA or similar. Investing works best when you view the money as “locked in”, which is why I think SIPPS are often better than ISAs (especially now that you don’t have to buy an annuity), because you CAN’T get the money back.
I think the illiquid nature of property is usually an advantage if you go into it with the idea that it’s a 10-20 year investment.
People like security in their mind when investing. I know many who have got into debt by investing in BOTH property and the stock market. Both are technically risks, but it’s how you deal with those risks that determine the final outcome. There’s a lot of success to be made in both investments as long as you play your cards right and take time to research & plan.