Real Estate Vs Other Forms of Investments – UK Specific
Over all other investments, real estate is King. Even in this economic crisis, real estate still reigns supreme over other investments. Let us compare and contrast some of the alternative investment options you have in addition to real estate.
A pension is basically an investment tool that allows an individual to set a fund that will provide an income upon retirement. For many years pension schemes have provided retirees with a decent income after leaving employment. The idea is that you save some money every month. The money is typically taken away at source by your employer and used to fund your pension scheme.
However, over the recent years there have been fresh warnings that Britons will not have enough money to live off when they retire. According to a recent article by the BBC, “In the past the government has been forced to admit that official estimates of the level of pension contributions had been inflated by a statistical error. The upshot is that many employees putting money aside for their old age may well find that their retirement income falls far short of what they had hoped.”
This effectively means that your pension scheme is unlikely to provide you with a decent income once you retire. What’s worse is that companies no longer provide generous guaranteed pensions where you would be guaranteed to receive a certain proportion of your salary in pension once you retire. Pensions are now on defined contribution basis and money purchase schemes and with no guarantees.
The reason for this situation has been two fold. To begin with, the average life expectancy in the UK has increased dramatically since 1980. Advances in the medical field have largely been credited with this. Between 1980 and 2000, life expectancy for men increased by five years whereas that of women increased by four years. This has led to people drawing on their pension schemes for a longer number of years than originally anticipated. Coupled with the increase in life expectancy has been the gradual decline in stock market returns. One third of shares in the UK market are controlled by pension funds. This is according to the UK Ethical Investment Research and Information Service. In fact this figure is likely to grow as more people are opted-in to company pension schemes under new laws.
To make matters worse pensions, pensions have had their dividend income taxed at 10% since 1997 with the election of the Labour government. As already mentioned, pensions rely heavily on stock market returns for their income hence the 10% tax on dividend income reduces their revenue.
The picture is even more depressing when you examine the returns over the last ten years and then compare that against the inflation rate over the last ten years. Over the last ten years up to 31 December 2008, the average pensions fund in the UK achieved a return of 3.7% p.a. In real terms, this represented a meager return of 1.1% p.a. against the Retail Prices Index (inflation). What this means is that in ten years the average pension funds in the UK only appreciated by 1.1%! This is cause for great worry. Ten years is a relatively long while. Assuming you contribute to a pension scheme (private or company) for thirty years, then it means that in a third of that period your money is just about stagnated, in this case at 1.1% per annum.
When compared to real estate, pensions do not come close. An average investment in real estate over a ten year period definitely yields a much higher return as will be demonstrated later.
UK Bond Market
There are a number of bonds available in the UK bond market. There are government bonds controlled by National Savings & Investments (NS&I), which represents Her Majesty's Treasury throughout the United Kingdom. Government issues bonds for a number of reasons, partly to raise money and partly as a monetary tool to control money supply in the economy and manage inflation.
There are also company bonds issued by private companies as a means of raising additional capital to fund new projects, marketing campaigns and so forth.
Bonds are tradable financial instruments; which means that you can buy a bond and sell it before its maturity date. Bonds pay a periodic income at certain intervals depending on how the bond is structured, say every six months. The principal amount is then paid at the date of maturity which may be anything from one year to 30 years.
Government bonds have the advantage of being low risk because it is considered almost impossible for government to default. However, this low risk also implies a low return. Company bonds offer higher returns but they also carry greater risk.
Bonds are suited to companies and individuals that have large amounts of cash they are looking to park. They offer liquidity because they can be sold off on short notice. They also offer stability because they are normally less volatile than stocks. Finally they offer income, albeit minimal income but income all the same.
Hence, bonds are not for someone looking for an above average return for their money.
The thing about the stock market is the high probability of burning your fingers. The stock market can provide a decent return especially over the long term but only if you know what you are doing. To benefit from capital gains, you must know when to get in and when to get out. You must literally have a finger on the pulse of the market at all times. Many people have struck it rich on the stock market but there are also the vast majority of individuals who have been turned into paupers overnight and whose stories are rarely told.
The current global economic crisis that has caused global property prices to deflate may seem to suggest that the stock market is a far better investment than real estate, reviving the age old question of stocks Vs real estate. Well, it actually all depends on when you get in. For example, U.S. real estate sale prices increased more than 56% from the beginning of 1999 to the end of 2004. The current low property prices in the US and Europe provide the opportunity to purchase property at a bargain. Between now and the time the financial crisis ends is the opportune time to acquire property.
UK Mutual Funds
Mutual funds are investment vehicles that invest your money in stock s, bonds and other securities. With mutual funds you have the advantage of being able to tap into large scale investing which would not be possible as a small investor. The mutual fund basically takes your £100 or £500 or whatever other amount and pools it with amounts from other investors.
As an investor, your claim to the portfolio is proportional to the amount you have invested. As an investor, you own shares in the investment company and your ownership is proportional to the number of shares you have purchased.
There are many different kinds of mutual funds in the UK market, each one serving a different kind of client. Broadly, these include;
• Equity funds – these kinds of mutual funds invest solely in the stock market and have the highest return. However, the higher return comes at an additional risk due to the volatility of the stock market.
• Income funds – these mutual funds in government and stable corporate bonds. The rate of return on these is quite low but they are stable and very low risk.
• Balanced funds – these mutual funds strike a balance between the two types above. They are medium risk and offer medium returns.
The thing with mutual funds is that other people are managing your money and you rarely have a say in where they put it. Mutual fund managers have over the years gained notoriety for investing in failed companies like Enron, Tyco and WorldCom.
Then there are the outright fraudsters such as Bernard Madoff who will divert your money for their own personal use and you will be none the wiser.
Starting a business
Starting a business is an investment option assuming of course you have the capital, know how and will power to do it.
One of the things that you should know about starting a business is even if you have the capital and know how; the odds are still stacked against you. The majority of business start-ups fail in the first year for one reason or the other. Starting a business can be an extremely stressful affair. It is a full time job that requires you to have basic knowledge in a wide range of disciplines if the business is to succeed.
It would be imprudent to risk your savings on a start up when great opportunities currently exist in the real estate market.
When you compare real estate investment to all the other alternative investment options, it becomes apparent that real estate has a number of advantages. The following are very evident;
Volatility – Real estate can incur you losses; the financial crisis is evidence of this. However, stocks, mutual funds and pensions would absolutely crush you. There is always the chance that a property you bought in future will eventually appreciate. However, with stocks, you can buy into a company and it collapses and is becomes bankrupt the next day. Pensions invest predominantly in the stock market so the risk is similar. Mutual funds can be taken to the cleaners by fraudulent fund managers.
Taxes – there are numerous tax benefits that derive from owning property in most parts of the world.