Shares or property: Which is the best investment?

Investment heavyweights shares and property go head to head as we explore which is the better way to build wealth.

a hand of a man in a suit points a finger towards old fashioned brass scales that are not balanced in the foreground of the picture.

Image source: Getty Images

Shares and property have long been the heavyweights of the investing world. But which is the best way to build your wealth?

Let's examine some important investing considerations and see how each investment measures up.

Shares or property: Which is the most liquid?

The more liquid an investment is, the more quickly and easily you can turn it into cash. This is important if you need to access your money in a hurry.

Shares have a significant advantage over property in terms of liquidity. 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 two business days) settlement process. If you need to sell shares, the cash will be in your account within three days.

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

On the other hand, buying and selling property can take months from deciding to buy or sell to a final settlement. Property transactions also incur 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.

Which is the most tangible?

A tangible investment is something physical that you can touch. Property is clearly the more tangible investment. 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, but you can also make it more valuable through renovations. 

Shares, meanwhile, are about as tangible as the computer records they are stored on. Shares represent part ownership of 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 fungible in that they can be interchanged with other assets of the same type. A company's board of directors can issue or create more shares, effectively diluting existing shares' value.  

For example, a company's board can choose to issue new shares to fund a valuable new project. This may generate shareholder wealth, but existing 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.

Which is the most tax efficient?

Tax is essential to consider before putting your investment dollars to work. 

In Australia, tax is levied on income and capital gains, whether earned through property or shares. In each case, you can also claim deductions for costs associated with the investment.  

One of the popular appeals of investing in property is that it can be negatively geared. What does negative gearing mean? This means the interest expenses and other costs of holding an investment property exceed the income it generates in rent. 

At tax time, investors can claim this loss to reduce their overall taxable income, thereby reducing their tax liability.

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. As the losses are tax deductible, negative gearing is helpful for high-income earners who can reduce their taxes while increasing their wealth through asset price appreciation.

It is important to remember that negative gearing is not exclusive to property. You can also negatively gear shares 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. 

A margin call means the investor must contribute additional capital to their margin account or sell some of the assets in the account. If the investor cannot contribute additional capital, they may be forced to sell their shares in a falling market, potentially incurring losses on their investment. 

That risk aside, however, if the cost of the interest on a margin loan is greater than the investor's dividend return, there will be a loss that you can use for tax purposes in the same way negative gearing works with property.

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. When a company pays dividends out of after-tax profit, it has already been taxed on its earnings. Investors get credit for this through franking credits that can offset the tax payable by the investor on the dividends. This prevents investors from getting taxed twice on dividend income.

For property, the tax advantage is depreciation. Depreciation is the reduction in an asset's value over time due to wear and tear. Property investors can claim depreciation expenses against their taxable income, even though they don't actually incur an out-of-pocket cost. 

You can claim depreciation on a property's building and the internal fixtures and fittings. This can add up to thousands of dollars a year! Other tax deductions, such as interest expenses, require you to pay the money to claim the expenses. 

The winner – it's a draw.

Share and property investments both have benefits and drawbacks from a tax perspective. Which is optimal for you depends on your circumstances and investment preferences.

Which is 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?

Regarding how much effort is involved, investing in shares sits at the passive 'hands-off' end of the spectrum. Once you make the initial investment, ongoing involvement is optional. 

To start investing in shares, an investor needs to decide on the best investing approach, set up a brokerage account, and research companies to invest in. Once done, 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, investing in index funds or exchange-traded funds (ETFs) is also possible. These funds spread your money over many different companies in one trade,  delivering instant diversification! 

On the other hand, an investment in property tends to be more 'active'. 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. 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 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 toward the share market, as this is where our passion lies. But personal finance is exactly that – personal. The right choice for you might be entirely different for someone else. In the debate between shares vs. property, the choice ultimately depends on your needs and goals. 

If you value tangible assets, can dedicate time to actively managing your investments, and don't mind a lack of liquidity, then a property investment could work 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, you must research your options to make an informed decision. The knowledge you gain will help you take control of your financial future, regardless of the type of investment you prefer.

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.

The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.