Stocks and Shares

In 2005, for the first time in 7 years, stocks and shares outperformed UK property - or did they?

 Despite the doom and gloom merchants who virtually all predicted a fall in house prices during 2005, the annual increase was 3.52%, against a massive 16.7% for the FTSE 100. However there are two things to bear in mind here.

Firstly, share prices are highly volatile and previous years have seen many double figure falls. Indeed, on 12th May 2006 the stock market had what economists call an adjustment, and crashed alarmingly. Since then although there have been some small recoveries the movement has been down. If you had invested £20,000 in the stock market 2 years ago it would now be worth £18,600, a loss of £1,400. The same £20,000 in invested in property, leveraged using other peoples money would have shown a gain of £31,300.

The stock market will eventually climb back up but the only people who make money are stockbrokers who make money whether prices are going up or down and those who actively trade. If you simply stick your money into shares and leave them then you are going to have to expect these wide fluctuations. Not too bad if you have the time to wait till the market climbs back up again - but if you need cash now - oh dear! Despite last year's gain you have to look at shares over a longer period of time.

Secondly, the figure of 3.52% is an average increase for in property prices in England & Wales but some regions showed 6% and 7% increases. More importantly the figure is based on actual prices paid for property. Where investors buy at a discount and then remortgage to release back their 15%-20% discount this doesn't show up in the figures. If you had purchased a property with 15% discount and then gained 3.52% on top you would easily have beaten the FTSE 100. But more importantly, you wouldn't have been using your own money so the return would have been much better.

Let me explain. If you invested £100,000 in FTSE 100 shares you would have ended the year with £116,700 - a gain of £16,700. However, if you had invested £100,000 in property you would have been able to purchase property worth at least £500,000 at the price you actually paid (ignore the discount for now). This is because you would only have to find 15% deposit and if we allow 5% for legal costs etc you would actually be borrowing 80% of the money you are investing. Your return would be 3.52% of £500,000 which is £17,600 - more than with the FTSE. Yes, you would have to pay interest on the borrowings, but your rental income would have covered that comfortably, even if you had some "void" periods where a property had no tenant. Investing in this manner is called "leverage" or as using OPM - "other people's money".

Already you are making more than on the stock market, but next you have to consider the fact that you have been buying at a discount. Lets assume that after all costs you only averaged 10% discount on these properties. The "open market" value of your property would be £555,555 - a capital gain of £55,555 to add to your £17,600 making a total of £73,155. A whopping return of 73.15% on your £100,000!

Just remember that the reports on house price increases really refer to owner occupied properties - its pretty irrelevant for property investors!

Pension Funds

The past 6 years have seen shares and pension schemes performing poorly as the public has witnessed one scandal after another. This has left many people worried about their future financial security because, with the demise of final salary pension schemes, they are no longer guaranteed a comfortable retirement income.

Confidence in the Government and the financial services industry is at an all time low and unlikely to change in the foreseeable future. Shares (and therefore pensions) are still very volatile and have never been a low risk investment option.

Government sponsored tax-free investments like ISAs have quite low maximum allowable values and will not in themselves lead to financial freedom.

Large financial institutions and pension funds are now investing more heavily in property (particularly commercial) because it offers sound long-term gains with minimal risk, compared with exposure to the Stock Market.

What Went Wrong?