We are often asked which is the better investment — property or shares? There is no definitive answer because, as with any kind of investment, it depends on your individual circumstances and what you want to achieve. But it’s crucially important that, in order to make a well-informed decision, you use accurate and reliable information. 

On the face of it, there’s a welter of evidence in support of property. The Australian housing market has defied expectations in recent times. The national Home Value Index rose 0.6% in February — the 13th consecutive monthly rise and the highest monthly gain since October last year.  

The longer-term picture for property investors has also been very healthy. Since the 1990s, Australian house prices have seen an increase of around 400%, while prices in Sydney have risen by even more. By comparison, Australian equity returns appear, at least at first sight, rather more modest. The ASX started the year 2000 at 3117; at the time of writing, it’s trading at about 7700. That’s not a bad return (around 150%), but it’s less impressive than the increase in house prices. 

Costs of Property Ownership – Are you seeing the full picture? 

When we consider movements in house prices, we generally think only about the movement in the price, and we ignore the return that comes from rent and the associated costs of owning and maintaining a property.   

According to Statista the average rental yield on houses at December 2023 was 3% in Sydney, 3.5% in Melbourne, 4.1% in Brisbane and 4.1% in Adelaide.  

A good rule of thumb for property maintenance is around 1% for newer homes and say 2% for homes that are more than say ten years old.  

On top of maintenance there are other costs of ownership such as: legal fees and stamp duty when buying, legal and agent’s fees when selling, as well as insurance, rates, and management costs along the way. All these costs add-up and can easily average out at an ongoing cost of around 2% pa.  

So overall, the net rental income from houses (after maintenance and other costs are deducted) can be negligible, making the price return most of the return in most cases.  

Returns on Shares – Are you seeing the full picture? 

The picture with shares is different to property. Investors who own the ASX 200 Index can expect a dividend yield of a little over 4%, which is roughly half of the long term expected return on this portfolio of shares. An additional benefit is that most of the dividend income is franked, meaning it comes with a tax credit, that serves to reduce the income tax you will pay on that dividend income.  

However, what many investors, don’t appreciate is that the ASX 200 Index, and indeed almost all the world’s major stock market indices, only tell part of the story. 

Let me explain. When you see an update on the ASX in the media, what you’re seeing is the price return. This reflects the change in the market price of the index since inception. It is calculated by comparing the current price of the index to its price when the index launched. Crucially, it does not include the dividends generated by the companies that make up the index. 

Dividends are a crucial component of investment returns (especially in Australia where they tend to be higher than in the US). As a rough rule of thumb, dividends account for about a half to a third of their total investment returns (depending on the stock market selected); the remaining half to two-thirds comes from rising share prices. 

Wall Street Journal columnist James Mackintosh recently put it like this: “Dividends are vital. Over the long run, the compounding effect of reinvesting dividends makes a huge difference to returns. In the past half-century, U.S. stocks turned $100 into $6,200 without dividends (ignoring costs and taxes) while with dividends they would be worth $25,000.” 

In other words, price returns give a very misleading impression of the returns investors in a particular index have received.  

For a comprehensive and far more meaningful picture, you need to look at total returns. The total return of a stock market index accounts for both the price appreciation and any dividends received.  

The good news is that, in most countries, investors have access to both price returns and total returns of their major stock index. 

The true value of the S&P/ASX 200 

Let’s have a look at the S&P/ASX 200, for example. As you can see from the S&P Dow Jones Indices website, the total return of the ASX 200 is currently around 98,000 — more than 12 times the current price return of 7700. Over the last 12 months, the price return is around 6.2 percent, but the total return is about 10.7 percent — a difference of 4.5 percent. 

It’s a similar story around the world. The S&P 500 in the United States for example, is currently at around 5,100. But, based on an inception date of 1970, if dividends were included the index would be somewhere around 31,000. The Dow Jones Industrial Average is around 38,000, but the true figure is nearer 96,000. 

In other words, by ignoring dividends, indexes like the S&P/ASX 200, the S&P 500 and the Dow Jones significantly under report market performance and are therefore inherently misleading. 

Equities have beaten property over the long term 

So, what does all this mean for those who are weighing up whether to buy a larger home, buy an investment property, or invest their surplus money in equities? 

Both property and shares tend to be good investments in the long run, and both have their rightful place in well diversified portfolio – so when considering this decision, investors should consider other factors such as:  

How much can you afford to invest? Property purchases tend to be very lumpy, whereas with shares it is easier to start small and incrementally add to your investment.  

Are you prepared to borrow to invest? Property purchases often necessarily involve leverage, or borrowing money to help you fund your investment purchase.  

Leveraging results in you investing your own money as well as the borrowed money. So, leverage avails you with the opportunity to make a bigger return (or loss) than you could make on your own money alone. This makes leveraging a riskier and more aggressive way to invest than simply investing your own money.  

This point is important because, many successful long term property investors cite property itself as the source of their terrific returns, when in truth, it is often leverage that has made the difference.  

Property investors often only invest 20% of their own money and borrow the rest. Whilst risky, this gearing strategy amplifies the good returns that property can deliver. However, it is important to note that the same is true for leveraging into shares. If you do the math, you will often find that applying the same leverage to an investment in the ASX 200 Index, provides a higher return than leveraging into housing. 

How well diversified are you? When choosing whether to invest in property or shares, it is worth considering what investments you already own. We all know that it is prudent to diversify your investments and not have ‘all your eggs in the same basket’. For many of us, we already have a significant property exposure by way of our own home. We also have exposure to shares through our superannuation and perhaps other investment portfolios.  

How you invest your next dollar, should consider how you are allocated overall. If you are already long property, then it may make sense to consider investing your marginal dollar in shares.  

Finally, whilst it is true that property has proved to be a good financial investment over the last 30 years or so, no financial market carries on rising indefinitely without enduring periods of poor returns at some stage. Over the very long term, equities have produced higher returns for investors than property once dividends are factored. The key is to choose an investment strategy that is fit for purpose for you, taking into account your circumstances and goals.