Friday, February 23, 2007
Choose your Vehicle!
There are basically three traditional investment vehicles available to the individual investor - Cash, Property and Shares.
By cash, I'm referring to investment in a mutual fund, term deposit, and so on. With this type of investment we earn interest income, and that's it. And even the interest is low - 4 to 10% and you're doing well.
With property and shares, as well as investing for income, we invest for capital gain.
With residential investment property, the income is the rent we receive as landlord. And more than likely, with the passage of years, the value of our property will go up - so when we sell we make a capital gain.
For some reason, people often find property easier to understand than shares. Really, it's quite similar.
When we buy a share in a particular company, we literally own a share in that company - that is, we are now a part owner of the business (although our ownership is likely to be an itsy-bitsy percentage).
With shares, our "rent" is the dividend we receive as shareholders - our share of the company profit. And as with property, we still hope that the value of the company has risen over time so that we can sell our shares for a capital gain.
So which is best - property or shares?
The standard answer is that it depends where we are in the economic cycle - the economy goes through phases, and different investments will perform better at different times.
This report by the ASX covers the ten year period between 1995 and 2004, and shows residential investment property and shares pretty much neck-and-neck in terms of returns... at least, before tax.
Dividend imputation on shares gives them a slight edge after tax.
Also shares do have some other advantages:
- they're liquid (easy to buy and sell)
- uniform (one share in a particular company is exactly the same as another)
- transaction costs are low (it's a lot cheaper to sell $500,000 worth of shares than pay commission on the sale of a $500,000 property!)
- barriers to entry are lower (you can get started investing in shares with a few hundred dollars - the way things are going with property, you'll need to work half a lifetime just to afford the deposit!)
- and shares can perform well in any phase of the economic cycle (that is, there are so many sectors to the market that there will always be one performing well whatever the inflationary environment).