Last Updated June 16, 2015
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 3 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 to 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 counter intuitive. 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 invested 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 is 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