| Debating the pros and cons of investing in stocks | | | | The power of Leverage can be seen in this simple |
| and shares versus investing in property is a popular | | | | example: |
| subject amongst analysts, brokers and investors. This | | | | In order to buy £100,000 worth of shares you |
| debate is often conducted under the guise of | | | | need £100,000 in cash, but to be able to buy |
| comparing traditional pensions versus property | | | | a £100,000 property you would typically need |
| investment, as most traditional pensions are invested | | | | £20,000 because you are able borrow the |
| in global stock markets. Stock market analysts will | | | | rest from a bank. Banks are happy to secure the |
| often accept that property is the better investment | | | | £80,000 loan against the property being |
| in a given year compared to stocks and shares. | | | | purchased, safe in the knowledge that people will |
| However they will often fail to take into account | | | | always need somewhere to live ensuring that |
| some of the major advantages that property | | | | demand for the property, and long term price rises, |
| investment has over stocks and shares when | | | | will almost certainly guarantee the safety of their loan |
| declaring that stocks and shares have out performed | | | | in the event of default. |
| property in another year. | | | | After a property is purchased and a mortgage is put |
| For example, a stock market analyst might attempt | | | | in place you are then able to rent the property out |
| to promote investments in stocks and shares by | | | | to service the cost of the loan and other expenses |
| stating something like this: | | | | and in many cases provide extra profit. |
| "Last year average property prices increased 7% and | | | | Using the above example we can examine the ROCE |
| the stock market was up 10% so stocks and shares | | | | in 2 scenarios, one in a year where percentage gains |
| performed better and represent a better | | | | were higher in property and another in a year in |
| investment." | | | | which percentage returns were higher in shares. |
| While the facts as stated, in terms of percentage | | | | Year 1 |
| gains, are entirely true, to claim that this automatically | | | | Capital Invested in Stocks & Shares = |
| makes stocks and shares a better investment is | | | | £20,000 |
| very misleading. It is understandable that, after giving | | | | Capital Invested in Property = £20,000 |
| such figures a cursory glance, you would believe that | | | | Asset Value at Start of Year Stocks & Shares |
| in the 'last year' you should have been investing in | | | | = £20,000 |
| stocks and shares. Indeed that is exactly the | | | | Asset Value at Start of Year Property = |
| conclusion the analyst might want you to reach. | | | | £100,000 |
| Gearing and the Return on Capital Employed | | | | % Increase in Value during Year in Stocks and |
| The Return On Capital Employed (ROCE) from | | | | Shares = 7% |
| property in this case will have easily been far higher. | | | | % Increase in Value during Year in Property = 10% |
| Why? Because you can borrow money from a bank | | | | Profit in Stocks & Shares = £1,400 |
| or other lending institution to buy property and | | | | Profit in Property = £10,000 |
| secure the loan against the property that is being | | | | Year 2 |
| purchased. This means that you only need to invest | | | | Capital Invested in Stocks & Shares = |
| the amount of your own money required to pay the | | | | £20,000 |
| deposit on the purchase rather than the full price of | | | | Capital Invested in Property = £20,000 |
| the property. This is often referred to as Gearing or | | | | Asset Value at Start of Year Stocks & Shares |
| Leverage and it is not something that can easily be | | | | = £20,000 |
| achieved when investing in shares. | | | | Asset Value at Start of Year Property = |
| Banks will generally not accept shares as security | | | | £100,000 |
| since they are considered highly volatile.Not only can | | | | % Increase in Value during Year in Stocks and |
| they go down in value as well as up but, they can in | | | | Shares = 10% |
| certain instances lose almost all their value in a very | | | | % Increase in Value during Year in Property = 7% |
| short space of time. Companies can quickly hit huge | | | | Profit in Stocks & Shares = £2,000 |
| difficulties due to factors such as poor management, | | | | Profit in Property = £7,000 |
| strong competition and unfavourable market | | | | As you would expect property provides the better |
| conditions. For example, shares in the HBOS group | | | | return in year 1 when property prices rose higher |
| were trading at around £12 each before the | | | | than share prices - delivering a massive 50% ROCE |
| credit crunch hit Britain, only to fall to be values at | | | | with just at 10% rise in prices. However, due to the |
| just a few pence during the height of the crisis. Such | | | | power of gearing, property also provides a far |
| volatility simply does not occur in property markets. | | | | superior return to stocks and shares (2.5 to1) in year |
| Despite all the media talk of a crash of epic and | | | | 2 when share prices rose higher than property prices. |
| unprecedented proportions in the UK property | | | | As you can see, the Return on Capital Employed |
| market between 2007 and 2009, the average house | | | | (ROCE) is a far better inidicator of profitablity than |
| price decline amounted to around 15% at its worse. | | | | the headline percentage return for an asset class. |