Shares vs. property vs. fixed interest
There are three main types of investment that produce higher returns than cash over time. These returns usually consist of both income and growth in the value of your investment. Let’s look at each in turn.
Fixed interest
You don’t always need to be a borrower in life—you can lend money, too. With fixed interest investments, you lend your money to the government or to companies. In return, they pay you interest over the term of the loan. The interest you receive is a ‘fixed’ return but if the investment is traded on an exchange, its value can rise or fall with changes in market interest rates. Over the long term fixed interest investments, as a group, tend to produce returns that are higher than cash.
Property
Most of us are pretty familiar with property. You may already own a home, although you may not think of it as an investment. Some people have an overly favourable view of residential property, mainly because borrowing can increase your overall return. What they fail to realise, though, is that they could be overextending themselves with too much debt.
You can also buy investments in shopping centres, office buildings and industrial property, most of which produce rental income. Sometimes various properties are grouped together in a ‘trust’ and you can buy ‘units’ in these trusts on the stock exchange. As with fixed interest, if units are traded on an exchange they can rise or fall in value. Property investments, as a group, generally produce returns that are higher than both cash and fixed interest over the long term. But that doesn’t mean that property prices can’t fall—they can and do.
Shares
These days, there are many different types of businesses, the so-called ‘engine rooms’ of the economy. It’s in business that people try to build a better widget or provide superior service than someone else. And when a business is successful, the returns can be very high indeed.
Shares, or stocks as they are sometimes known, represent part ownership of these businesses. So, by buying shares on the Australian Stock Exchange, you can participate in the growth of the economy. What’s more, you can buy and sell shares easily and quickly. With property you can’t sell off the third bedroom if you need to raise some cash. But as with all investments that have the potential to rise in value, shares fluctuate from day to day. Over the long term, though, Australian shares have performed better than property, fixed interest and cash. Take a look at the chart below to see how the various asset classes compare.
Source: Vanguard Investment
These are quite startling figures that show the ‘miracle of the compounding of interest’. Over long periods of time, even small differences in rates of return make a huge difference in total returns. So, by ignoring shares you are depriving yourself of the opportunity to earn better returns than you can from any other asset class. But before stepping into shares, you need to know the risks and benefits.
Further Reading
- For more information on the importance of the compounding of interest, the Motley Fool site has an excellent introduction at www.fool.co.uk/school/compound.htm.You'll also find some useful calculators to show you how your savings can grow.
- For a different take on the same issue this article looks at the tyranny of compounding: how seemingly small fees can eat away at your returns.
- Wikipedia provides a thorough look at the rule of 72, or the time it takes for an investment to double (or half).
