This article was published on 9 May 2006. Some information may be out of date.

Index distortion not what it seems

A reader’s point about the ongoing shares v houses debate sounds fair enough.

“Your comparisons do not compare like with like,” he writes, “because you are using an index for shares, which only covers some companies, whereas for housing, you are using the average over all houses.”

He adds, “It seems to me that an index by definition excludes failing or failed companies. Would not a failing company fall off the index, whereas a house losing value remains in the calculation of the average house price?”

Others have made the point before. But it’s not valid.

The stock exchange has several share indexes, basically covering: the biggest 10, 15 and 50 companies; mid-size companies; small companies, and the whole lot.

When someone talks about market performance, they are usually quoting the NZX 50 index, largely because it has been around, in various forms, since 1967. Other indexes don’t give the same historical perspective.

In any case, the top 50 companies make up 87 per cent of the total value of all listed shares. So the NZX 50 index and the NZX All index are pretty similar.

Actually, in recent times, those who quote the NZX 50 have understated share performance. In the 15 years to the end of 2005, the top 50 index rose 12.2 per cent a year while the total market rose 13.6 per cent.

And that makes quite a difference. Over 15 years, $10,000 would grow to $56,200 at 12.2 per cent, but $67,700 at 13.6 per cent.

Okay, our reader may be saying, but even if we use the NZX All index, we’re still excluding companies that fail and are delisted from the stock exchange. True, but:

  • their price decline drags down the index as they are failing. It takes a while before a company is dropped from an index.
  • we also exclude new companies that haven’t yet listed but whose share values are growing fast.

Let’s say there was an index of every share, including tiny unlisted companies and companies going bankrupt. That would be more directly comparable with the house price index. And my guess is that it would perform better than the NZX All index.

After all, the stock exchange’s small company index has performed much better than the NZX 50 over the last 15 years, growing at 19.2 per cent a year. And companies that are even smaller might be expected to perform even better on average.

Small companies are riskier than big companies, and riskier investments tend to bring in higher returns.

Unfortunately, there is no Every Share Index. So let’s look at what we have got to work with.

As I said, the NZX All index grew 13.6 per cent a year over the 15 years. QV’s house price index grew 7.0 per cent a year — at about half the pace, despite the recent boom.

But wait. The share indexes quoted all include dividends, while the house index doesn’t include rent.

How much rent should we include? I haven’t seen any good data on average net rents. But I would be surprised if many rental properties yielded as much as 6.6 per cent — the difference between 13.6 and 7 per cent — after allowing for insurance, rates, maintenance, periods without tenants and so on.

And if we had an Every Share Index, the rental yield would probably need to be higher for houses to top shares.

Waiting in the wings is another reader, who has written about how we usually borrow to buy property and how that affects all of this. We’ll look at that in two weeks time.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. 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.