Shares vs Property: Which is the best investment?

Shares or property: Which is the best investment?

The two heavyweights of the investing world have long been shares and property. But which one is the best way to build your wealth? Let's step through some of the important factors of each and see how they measure up.

Shares or property: Which is the most liquid?

Investments that are more liquid can quickly and easily be turned into cash. This is important if you need to access your money in a hurry, say to replace the car or help family members in need.

Shares offer a big advantage here. Large share markets like the ASX bring together a huge number of buyers and sellers in one place, creating incredible liquidity

Transaction costs to buy and sell are low and settlement occurs quickly with what's called the 'T+2' (trade date plus 2 business days) settlement process. If you need to sell shares, the cash will be in your account within 3 days.

The liquidity of shares and their small prices per unit also makes it easier to spread your risk by diversifying across different companies in different countries. Diversification is important because the share price of a single company can be much more volatile than property prices, moving up and down quickly over short periods of time.

Buying and selling property, on the other hand, can take months from the time you first decide to buy or sell to final settlement. Property transactions also come with much higher transaction costs, including real estate agent fees and stamp duties, which eat into your returns.

The winner – shares.

Being able to buy and sell quickly, with low fees, and the ability to spread your risk across different companies are important advantages to owning shares.

Shares or property: Which is the most tangible?

You can drive past your investment property (and occasionally paint it!) but you’ll never hold your shares in your hands. Not only is property tangible, you can make it more valuable through renovations. 

Shares, meanwhile, are about as tangible as the computer records they are stored on. Shares represent ownership in a business, but if you own shares in a big bank or retailer and walk past a physical branch or store, you still can’t walk in and decide what colour to paint the walls.

Shares are also fungible and more of them can be created (issued) almost instantly by a company's board of directors, which effectively dilutes the value of the shares you own.  

For example, a company's board can choose to issue new shares to fund a valuable new project. This means shareholders face the risk of having their share of profits diluted if they do not buy a proportionate number of the new shares issued.

The winner – property.

When it comes to touching, controlling, and customising an investment, you simply can't go past investing in property.

Shares or property: Which is the most tax efficient?

Tax can be an important factor to consider before putting your investment dollars to work. 

In Australia, both shares and investment properties are subject to capital gains tax on similar terms when sold. The income derived from both investments (rent or dividends) is subject to income tax on similar terms. 

One of the popular appeals of investing in property is that it can be negatively geared. What does negative gearing mean? This is when a property makes a loss after deducting interest expenses and other costs from the rental income received. 

At tax time, any loss will reduce your taxable income, thereby reducing the amount of tax you have to pay.

Why is this a popular strategy? The theory is that property will grow in value over time and deliver a much larger return through capital gains down the track, which justifies the small annual losses. Given the losses are tax deductible, negative gearing has been a particularly handy tool for high income earners who can reduce their taxes while growing their wealth through asset price appreciation.

Negative gearing is not exclusive to property. Shares can also be negatively geared if you borrow money via a margin loan to invest in them. 

Borrowing to invest is called ‘investing on margin’ and adds additional risk to a portfolio because of the volatile nature of share prices. Unlike a mortgage, most margin loans allow the lender to make a ‘margin call’ to the borrower if their loan-to-value (LVR) falls below an agreed ratio due to falling share prices.

That risk aside, however, if the cost of the loan interest is greater than the cash return from the dividends, there will be a loss which can be used for tax purposes.

Shares and property each have one big tax advantage that the other does not. 

With shares, the tax advantage is franking credits on dividend income. Dividends get paid out of a company's after-tax profit and franking credits represent the amount of tax the company has already paid on those earnings. This prevents shares investors getting taxed twice when investing in dividend-paying shares.

When you hear the term ‘grossed-up’ dividend, that means the dividend plus the franking credits. So, if a company is paying a 4% yield that is 100% franked, the franking credits will add about 1.7% to create a grossed-up dividend of 5.7%.

With property, the tax advantage is depreciation. This is an ongoing annual ‘cost’ that does not come out of your pocket (how good is that?) but can be claimed as an expense to reduce your taxable income. 

The younger the property, the better the depreciation. You can claim depreciation on both the building and the internal fixtures and fittings. This can add up to thousands of dollars!

The winner – it's a draw.

Investments in shares and property are treated fairly similarly from a tax perspective in Australia. Although we have no obvious favourite, your personal circumstances might mean you prefer one over the other.

Shares or property: Which can be the most hands-off?

When you think of investing, do you think of lazy afternoons at the beach, or rolling up your sleeves and getting to work?

In terms of how much effort is involved, investing in shares certainly sits at the passive 'hands-off' end of the spectrum. 

To start investing in shares, an investor needs to decide on the best investing approach, set up a brokerage account, and start researching particular companies. Once that is done, the ongoing management of a share portfolio can be relatively easy, with just some regular monitoring of company reports and performance required. 

If this sounds like too much work, there is also the option of investing in index funds or exchange-traded funds (ETFs), which spread your money over a large number of different companies automatically, in one trade, and for a relatively low management fee (compared to managed funds). This delivers instant diversification! 

Investment properties, on the other hand, tend to be more ‘active’ investments. In fact, compared to a share portfolio, investment properties can be a lot of effort! 

If you've ever owned your own home, you can appreciate just how much work is involved in keeping a property in good condition. On top of that, property investors also need to manage the tenants who will pay the rent each week or month. 

The alternative is to hire a great property manager to look after the investment on your behalf. This can make the investment more hands-off, but will cost a small slice of your rental returns on an ongoing basis.

The winner – shares.

If your ideal investment lets you spend more time doing what you love, investing in shares is by far the better option.

Shares or property: Which is right for you?

At The Motley Fool, we have a natural bias towards the share market, as this is where our passion lies. In the debate between shares vs. property, the choice ultimately depends on your needs and goals. 

Personal finance is exactly that – personal. The right choice for you might be completely different for someone else.

If you value tangible assets and can dedicate time to actively managing your investments, and a lack of liquidity isn’t a problem, then an investment property is for you. 

On the other hand, if you value flexibility with your investments and want to diversify your assets, and you prefer the ups and downs of the market to dealing with fussy tenants, then shares could be the winner for you.

However you decide to invest your money, by researching your options you are well on your way to taking control of your financial future.

Last updated 9 March 2022. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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