So, you are sitting around a BBQ at your best friend's place, over the Christmas break, eating a few prawns, maybe having a beer or two.
I wouldn't be surprised if the topic of property comes up…
Many Aussies really seem to have a love affair with residential property, and the topic is frequently a headline on the news.
Investment properties have become very popular over the past few decades, with strong price rises in our major capital cities, especially Sydney and Melbourne, and there is no doubt that many investors have done very well.
But it's important to understand that the vast majority of the people have borrowed to invest in these properties, many with leverage of 80% to 90% or even higher.
While property prices have been less volatile than shares over the past few decades, when you factor leverage into the equation it can become a different story…
For example, let's take a typical investment property purchase.
Say you purchase an investment property for $400,000, with an $80,000 deposit.
If property prices rise 5% in a year, then great, your property is now worth $420,000 (on paper). That means theoretically that your $80,000 deposit has increased in value to $100,000, which is a 25% gain.
But this also works in reverse. If property prices go down 5%, the value of your initial investment has actually fallen by 25%.
In the past 18 months we have seen strong market correction in most capital cities, many falling by even more than 5%.
And this doesn't take into account the additional costs involved in purchasing a property, such as stamp duty and solicitor fees.
Many people like property for rental returns, but it's important to factor in additional costs including agent management and letting fees, periods where your property is vacant, and maintenance costs. And longer term, there are kitchens and bathrooms upgrades and painting etc. It all can become very expensive and actually require a lot of time and effort to keep on top of everything.
Shares provide instant diversification
I think one of the main reasons people invest in property is simply because it is a type of investment that they can understand. Unlike shares, property is seen as a tangible asset that they are familiar with. But that doesn't necessarily make it a better investment…
On average, shares have returned around 10% per annum including dividends over the past few decades, making them a great long-term investment.
Take, for example, an investment in just one quality company like Wesfarmers Limited (ASX: WES). By investing in Wesfarmers shares you get instant exposure to a range of high-quality companies and industries, rather than investing all your money in one lumpy asset. Wesfarmers is a highly diversified business with operations in general retail segments including home improvement and outdoor living, and office supplies, as well as industrial segments with operations in chemicals and energy.
You can take this diversification story further by investing in a range of other ASX shares, such as Commonwealth Bank of Australia (ASX: CBA), Telstra Corporation Ltd (ASX: TLS), Macquarie Group Ltd (ASX: MQG), BHP Group Ltd(ASX: BHP), REA Group Limited (ASX: REA) and Cochlear Limited (ASX: COH).
By doing so, you are not only spreading your risk into more market segments, but you are spreading your risk amongst a range of separate share listings.
In addition, you get can get started in shares with a lot less money. While your property investment deposit maybe $80,000 or more, just $20,000 can easily get you started on investing in a portfolio of 10 different shares.
ETFs are an even simpler way to get into the share market
If you have an even smaller amount to invest, say $2,000, you could invest in an exchange traded fund (ETF), such as Vanguard Australian Share ETF (ASX: VAS), giving you instant access to a very broad range of Australian top 300 largest companies by market capitalisation.
This is a great way to put your toe in the Australian share market, and doesn't require you to have to continually monitor your investments.
Once you gain more confidence in share investing you can then look at investing in a range of separate listed shares.
Foolish takeaway
There is no doubt that residential property is a good long-term investment, however I prefer investing in shares due to the lower initial cost required, diversification, lower fees and better long-term performance.
