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The quandary remains – for long term profitability is it better to buy property or invest in shares? And if you are buying shares should you buy Australian shares or international? The mathematicians are forever doing the calculations and as the market changes so do the numbers. Here’s some background to the whole dilemma to help you understand the big picture.
Equity, collateral and “good risks”
When it comes to securing a loan for investment, the banks can still tend to be a little old fashioned. The more collateral you have, the more they will lend. The preferred form of collateral is property. With a property behind you it is usually possible to borrow for other investments – shares or another property – as long as you have enough equity in that property. (Equity is the difference between what you paid and what the property is now worth). If you want to borrow to buy another property you will probably be able to borrow more money than if you are borrowing to invest in shares.
Did you know McDonalds is one of the world’s biggest landholders? As the legend goes, in the early days when they were looking to expand the banks refused to lend them any more money as, if things went sour, all they had to sell were burgers… the argument being “What if people don’t want to eat your burgers anymore?”. At that point the company started to acquire property. The rest, as they say, is history. The banks loaned the company money to expand. McDonalds now has restaurants in more than 100 countries.
Having something to sell (“bricks and mortar”) makes the banks more comfortable about lending you money (a “good risk”) whether it is to buy a home or to invest in the share market.
Property vs shares investment
Australians love property. Per capita Australians invest more heavily in property than any other nation on Earth. Australians buy homes but also invest in property trusts. Why? Bricks and mortar are perceived as safe and a good earner over the long term. Home owners are considered wealthier than people who do not own their own home.
Is property a safe bet?
But is it true? Is property a safe bet? The data shows that blue-chip shares are actually about as stable and secure and may even make you a bit more money over time. Blue-chip shares are expensive to buy though and few people borrow as much money to buy shares as they would for a house… which means they make less in the end though the average return may be about the same percentage wise.
However, buying property is not without risks.
Property is a major investment, which requires an average commitment of 25 years or more. In addition, costs such as maintenance, insurance premiums and council rates are ongoing, eating into any potential profit.
By the time the loan is repaid, most investors have paid tens of thousands of dollars in interest and interest rates have been on the increase since the Howard Government. These things need to be considered when deciding whether or not to invest in property.
Shares: worth the risk?
Shares are, of course, more risky than property, all other things being equal, even simply because it is harder to sell a property fast. This has the effect of reducing panic sales (if interest rates rise, for example) – whereas shares can be traded in a day. In the world of shares and stocks, a bad day can have a ripple effect – and as investor confidence plummets so can the markets. Historically, many small-time investors have lost their life savings because of a “bad day” and because they failed to adequately diversify their portfolios.
However, with sound advice and a well-planned portfolio, shares investment can be a very profitable, low maintenance way to earn money. The question remains as to whether or not a loan is an appropriate way to buy shares on the stock market.
Personal investment loans and mortgages
While the biggest disadvantages to investing in property might be the hefty commitment and long time frame required, most home loans do have much lower interest rates than personal loans.
Despite this, securing personal loans, for the purpose of margin lending, has become a very important part of many people’s investment strategies in recent years.
Also known as “gearing”, margin loans allow investors to put money into shares, managed funds, master trusts and wraps. More risky for a financial institution (and the lender), the collateral for these loans are the investments themselves.
While margin investing is not for everyone, some banks boast that it allows people to invest up to three times more money than they could alone.
Unsecured investment loans
Of course, it is possible to get unsecured loans for investment as well, but these will typically be for a much smaller amount, usually from $500 to $40,000. A secured loan could be for as much as $80,000.
Obviously these loan amounts are nowhere near as high as compared to the amount banks will lend for property investment, and this makes sense. If a bank has to foreclose on a property loan, the chances are they will manage to recoup their money when the property is sold. However, if the stock market crashed, it would be virtually impossible for the banks to recoup their losses. This could have a devastating effect on the economy if the crash were sizable enough.
At the end of the day, it’s all about collateral. If you’ve got something “real” to cover your loan - a building – the banks are more comfortable about lending you money. In some cases, blue-chip shares can be used in the same way, but lenders may value your shares differently to you so you may need to put many more forward to achieve the same level of security.
