Sunday, 20 December 2009

Why shares beat property

Why shares beat property
How many realise that shares remain ahead of property over the past quarter century?

Ian Cowie
Published: 7:42AM GMT 18 Dec 2009

Short of a miraculous surge in the stock market, the end of this month will mark the close of a dismal decade for shares.

Most investors know that the FTSE 100 has never revisited the peak of 6,930 it briefly hit on December 30 1999. But how many realise that shares remain ahead of property over the past quarter century?

Yes, you may very well stretch your eyes. I did, too, when Andrew Bell, head of research at Rensburg Sheppards Investment Managers, first told me.

I was almost as surprised when his graceful consultant, Jain Castiau, talked me into taking a dawn dip with her in the near-freezing waters of the Serpentine this week. At least it wasn't snowing at the time but, hey, that's another story.

Back to the statistics. The comparison, as you can see from the graph on this page, is based on the Halifax house price index and the FTSE 100 total returns index; both being the best-known benchmarks for their respective assets.

Or nearly. Because, as sharp-eyed readers will already have noticed, this version of the Footsie is the "total returns" version. In other words, it includes dividend income.

That is an important difference from the most widely quoted form of the Footsie which, for the purposes of simplicity, only measures changes in capital value or share prices, excluding dividends.

That goes a long way toward explaining why so many people underestimate the value of shares and share-based funds as a means of storing wealth.

Dividends are an important part of the total returns from most shares, but they are completely excluded from the simple snapshots of changes in capital values that form the basis of most television and tabloid stock market analysis.

No wonder the figures look so bad because they are so wrong.

Even after this year's splendid stock market rally, the Footsie is still yielding a shade under 3.4pc. That is, dividends expressed as a percentage of share prices averaged across the 100 stocks in this benchmark index.

So, for example, even if share prices remained frozen for 20 years, you would double your money in less than that time simply by reinvesting dividend income.

Bear in mind that income paid by equities is quoted net of basic rate tax – so most investors would need gross returns of 4.25pc and high earners would need 5.6pc to match the yield on the Footsie.

Few bank or building society deposits pay that much income – although, unlike shares, they do provide a capital guarantee. Bonds and bond funds often pay more – although, unlike shares, fixed interest securities are very vulnerable to inflation.

All things considered, it is daft to ignore dividend income when measuring returns from shares. For starters, the full picture demolishes the cliche of a ''lost decade for shareholders''.

What's that I hear you say? When comparing housing and shares it would be totally unfair to include income from one asset, but not the other. Too true. Mr Bell was scrupulously fair and has factored into his calculation a 5pc rental yield on property, less 1pc maintenance costs.

That's even fairer to bricks and mortar than it sounds because the Investment Property Databank UK Residential Index is currently yielding only 3.2pc gross and, of course, it is much easier to reinvest relatively small sums of income in shares than it is to buy tiny bits of houses.

Needless to say, the total returns from any asset would be much lower if you failed to promptly reinvest income because the compounding effect, so marked over long periods of time, would be absent.

Against all that, it just doesn't feel right to say shares have proved a better bet than bricks and mortar over the past quarter century.

Most shareholders are also homeowners and, while equities have delivered higher returns than most media coverage would suggest, I would hazard the guess that bricks and mortar have contributed more to the total wealth of the majority of homeowners than equities did.

The explanation is gearing. Until recently, almost anyone could fill in a few forms and borrow 100pc of their investment in housing. Such easy credit has never been available for shares.

And, of course, stock-market profits are generally subject to capital gains tax – unless you obtain them via an individual savings account or pension – whereas gains on your home are always CGT-free.

Even so, Mr Bell's comparison remains surprising and encouraging at a time when so much analysis of the stock market is merely depressing.

And it is always true – as I recalled while splashing through the gelid lake in Hyde Park this week – that the more you look, the more you see.

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