Bigger and better houses distort numbers
Readers keep sending in thought-provoking letters about the shares v rental property debate. It’s central to the question of how to invest long-term savings, so it’s worth continuing to explore the issues.
Today, excerpts from two letters:
“Your reader who commented on comparisons between housing price indexes and share market indexes has overlooked many points. Sometimes very large amounts are spent on home improvements without being considered when calculating house price increases.
“With new houses, a trend for larger houses and obviously the higher cost for more square feet will also distort the figures to indicate asset value growth where there is none.
“As with many things, it’s probably an issue of ‘seeing what you want to see’.”
My response: Taking your last point first, we certainly do pay more attention to data that support our views and our investments. But it’s worth trying to rise above defending decisions already made. If we are open to doing things differently from now on, we might well end up better off.
You’re right, too, about how house price data don’t allow for improvements. When people say their house value tripled in 20 years, they often forget that they spent plenty adding a second bathroom, garage or deck, or just upgrading quality over all.
What about house size? In 1977 the average new house was 127 square metres. It’s now 175 square metres, a huge 38 per cent bigger, according to government statistics.
What it all means: The value of the average house hasn’t risen as fast as the house price index — unless the owner made improvements, in which case he or she needs to allow for the cost of those.
- “Sensible investors will have exposure to real estate, stocks, fixed rate deposits, and even perhaps precious metals. None of them perform similarly to each other and that is the reason you diversify.
- “The problem when comparing the NZ stock index to property is that most investors will purchase the individual stocks that comprise the index as opposed to buying the index as you would in the US market. Investors who buy shares in individual companies are at risk of 100 per cent loss of capital on that particular investment.
- “In effect, stocks HAVE to return more than property if only to accommodate the risk of capital loss.
- “The risk of 100 per cent loss is not as small as investors would like to believe. Think of these high fliers from the 80’s — Chase Corporation, Equiticorp, Bond Corporation, Skase Holdings. Currently, there’s Enron. Compare that to the property market where time is the investor’s friend.
- “The answer to all problems comes in diversification.”
My response: Many New Zealanders do, in fact, invest in index funds — which are, in my opinion, the best way for smaller investors to get into shares.
But you’re right, many prefer to directly own shares, and they do risk losing the lot in a single company. The harm that does is greatly reduced, though, by owning many different shares, some of which will do exceptionally well.
Note, too, that in property investment nearly everyone gears, using a mortgage. That means they not only risk losing all the money they put in, but they may end up owing more to the bank. In my last column I gave an example of how that could happen over 15 years — using reasonable assumptions.
The upshot: It’s risky for anyone to have all or most of their savings in anything that could lose all its value — whether it’s a single share or a single geared property investment.
As you say, diversification is best.
Mary Holm is a freelance journalist, a director of the Financial Markets Authority and Financial Services Complaints Ltd FSCL, a seminar presenter and a bestselling author on personal finance. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.