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Place your bets wisely in the investment return race
Equities win by a long head while mortgages, gilts and property trusts bring up the field, writes LEIGH ROBERTS
There's no doubt about it, the stock market is the clear winner in the long-term investment stakes. It's unwise, though, to put all your savings in the stock market. Your best bet is to spread your savings mostly between the stock market and investing in your own mortgage bond, with a much smaller portion in gilts (long-term interest investments) and in property trusts (listed shares investing in commercial and industrial property). That's the advice of CEO of stockbrokers Fleming Martin, Winston Floquet, who each year releases a comprehensive report on the performance of different investments.
Floquet says in the last three years, the stock market has rendered disappointing returns and has been beaten by gilt investments (on a pre-tax basis). However, over the five- to 38-year period, investing in the stock market has come streaks ahead (on an after-tax basis). In the 20 years from 1978, the stock market (equities) rewarded its investors with a superior average growth of 25% each year. Over 38 years the annual return has been 19.6%. The accompanying graph tells how equities outpaced other investments which are popular with individual investors. The graph holds a wealth of information and details the complete investment story. It shows how the actual returns on investment (pre-tax in the graph) are eaten up by income tax and further diminished by inflation. As an investment should always be considered together with its related risk, the standard deviation figures are shown (this is the volatility of the returns over 20 years). In the pre-tax performance returns race, equities are first past the winning post, followed by property trusts, and then in third place, investing your extra cash in your mortgage bond. The results of the after-tax returns race are quite different - and highlights the enormous threat tax poses to investors. Equities still cross the finishing line first (at 23.8%), but second place now goes to investing in your mortgage (at 16.6%). Third spot goes to property trusts (at 12.9%). Equities hold the privileged position of being tax-free investments to the average investor. Dividend income is not taxed and the capital profit you make when you sell the shares also escapes tax, provided the shares are held for more than five years (as a general rule). By contrast, investments which give out interest income are hit hard by high individual tax rates, and this cuts their after-tax returns. Investing in your own mortgage bond can be considered a tax-free investment. The rationale is that in so doing you avoid receiving interest income, and this saves you the tax you would have paid had you invested that money in a bank deposit or other interest-earning asset. The graph highlights that other major threat to unwitting investors - inflation. Over the 20-year period, inflation averaged at 12.7% a year. Disturbingly, only three of the seven investments beat inflation with their after-tax returns. Those investors who went into fixed deposits, gilts, participation mortgage bonds and Krugerrands would have lost some capital each year to inflation. While equities are the clear winner in this investment story, they are risky assets (second only to Krugerrands in the volatility stakes). The standard deviation on equities is 25.1, compared with 15.3 for property trusts, and a negligible 3 for investing in your mortgage. Floquet points out that while the volatility risk is high for equities, the risk to the investor lessens to an acceptable level the longer the investment is held (10 years and longer). In the short term, investors may find the volatility risk of equities too costly - you might just have to sell your shares when prices are at one of their periodic lows. If the after-tax return figures in the graph are divided by the standard deviation (to give you a risk-adjusted return) then investing in your own mortgage is the outright winner. For this reason Floquet advises you to spread your wealth mostly between equities and investment in your mortgage. "The balance between the alternatives will depend on the investor's existing asset mix, the availability of new funds for investment, and the investor's tolerance to risk," says Floquet. The younger the investor, the more of their wealth should be in the stock market as they can afford to take the extra risk - and reap the higher returns - because their youth dictates a longer investment holding period. Floquet notes that the case for investing in balanced funds has improved in the current economic climate of lower inflation and attractive real interest rates.
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