How should your split your wealth between shares and property?

property and shares

Australian’s have a well-documented love affair with property. Many people pursue the “great Australian dream” of owning their own home and over 2.1 million taxpayers invest in property. Most Australian’s also invest in the share market too, via their superannuation.

However, one of the decisions that many people struggle with is whether to invest in property, shares or both. And if the answer is to invest in both, how much do you invest in each and is it wise to do one before the other?

Like with many things in life, moderation is the key

All things being equal, diversification is typically the wisest approach. Spreading your money across various asset classes helps you reduce your investment risks. Property and share investment returns are not correlated, so by investing both, hopefully the ‘good’ years in property will randomly offset the ‘bad’ years in shares (and vice-versa). That is less important in the long run, but in the short run, diversification smooths investment returns, which makes the road less bumpy and less stressful.

Don’t invest if you are uncomfortable

Whilst you should always aim to never let your emotions guide financial decisions (as discussed here), sometimes people are very uncomfortable with investing in either property or shares.

I believe that you should never invest in anything unless you are 100% comfortable. Therefore, if your risk tolerance drives you to invest in one asset class only (i.e. property or shares), then that is okay as long as you use the correct investment methodologies. At the end of the day, the quality of your investments is more important than your level of diversification, especially in the long run.

You probably don’t need to invest in more than two investment-grade properties

Some businesses and articles online promote the benefits of acquiring a large property portfolio. Whilst this might be realistic for some, it’s completely unnecessary for most people. Of all the financial plans that I formulate, I rarely recommend my clients invest in more than three properties. In fact, most plans involve investing in one or two.

There are two reason for this. Firstly, quality trumps quantity every day of the week! It is much better to put all your money in one high-quality property than spread your monies across several “average” quality properties.

Secondly, limiting the amount you invest in property leaves room for you to invest in other assets such as shares, thereby achieving better diversification. However, if you max-out your borrowings (through investing in property), you will probably find that you do not have any capacity to invest in other asset classes.

Beware of anyone that suggests you can and should invest in lots of properties. Your ego must not determine your investment strategy. That is often difficult to do without having to make significant and ultimately costly compromises on the quality of the properties you invest in (unless you have a significant income).

Most pros and cons balance themselves out at a portfolio level

The shares versus property debate has raged on for many years. People in each camp will highlight the pros and cons in each. For example, shares are more liquid, you can invest in shares in smaller amounts, you don’t have to worry about dodgy tenants and so forth. Whereas, for property, people are attracted to the tangible nature of the asset and you can borrow more (at lower rates) to invest in property. These are just some of the pros and cons that are often mentioned.

Most of the pros and cons regularly mentioned are technically correct. However, it’s not really a meaningful debate. Its tantamount to debating which is your favourite golf club; a putter or a driver. Both clubs are used for two completely different tasks. One isn’t better than the other. That is nonsense. It depends on what you want to achieve with your shot – you select the right club for the right shot. All golfers carry at least one of each type of club in their bag.

The same is true for property and shares. They each have their unique pros and cons. However, in a diversified portfolio that includes both property and shares, these pros and cons tend to offset/negate each-other.

It’s not about returns

It is erroneous to assume that property will generate better returns than the share market or vice versa. As I highlighted in my book Investopoly, Over the past 25 years the Australian stock market has generated 9.30% p.a. in returns. The US market did 10.5% p.a. And the Australian property market has produced 12% p.a. over the past 30 years. I think it’s reasonable that either asset class is likely to generate relatively similar investment returns in the long run. Of course, the split between capital growth and income is different, which is important as I’ve explained here.

Watch out for vested interests

As Buffett says; you never ask your barber if you need a haircut! Therefore, don’t asked a property developer whether you should invest in property or a stockbroker whether you should invest in shares. You must ask someone that is independent. Someone that has no investments to sell you, be it property, shares or anything else. I have written a couple of blogs that might help you find the right advisor here and here.

Independence is worthless without experience

There are many firms that advertise that they are independent, but that is only half the challenge. The firm’s depth and breadth of experience across all asset classes is arguably equally important, because it will guide the advice they provide. For example, if an advisor has very little experience with investing in property, they may be reluctant to recommend it (and know when and how to recommend it).

I believe the most valuable thing an advisor has to share with you is their experience. Knowledge will tell us what to do, whereas experience tells us how and when to do it. Knowledge without experience is dangerous because you risk doing the right thing at the wrong time or in the wrong way, and completely messing it up. That’s why medical students need to accumulate over 10 years of experience before they become surgeons, because experience cannot be taught. There are no short cuts.

An advisor with an equal amount of experience in both property and shares will be able to independently decide which asset class you should invest in with absolute credibility. Conversely, advice from someone with imbalanced experience lacks credibility.

In short, here’s what I typically aim for

I’m sure you want the answer… to know how much to invest in each asset class. I have tried to explain this previously in this video. However, in short, by the time my clients retire, I typically like to have their wealth invested in:

  • One or two investment properties;
  • Plenty of cash in loan offset accounts such that their property portfolio is no longer negative cash flow (at least two years of living expenses in cash);
  • Substantial super balances that are well invested; and
  • And if cash flow allows, a diversified portfolio of low-cost index funds in personal name (or a family trust).

All of these assets should comfortably fund retirement without eating into capital.

If you would like to discuss your personal investment strategy with us, please do not hesitate to reach out.