Returns of the decade

Residential real estate is a much-loved investment and everyone seems to know someone who has doubled their money playing property. Shares have their legions of fans, while others prefer the security of cash.

But to settle the question of where has been best to invest over the long term, Money asked AMP Capital Investors and SuperRatings to supply the 10-year returns for six asset classes, plus superannuation.

The results will disappoint the bricks-and-mortar brigade, because they show Australian shares win hands down. Not only have domestic shares outpaced overseas shares, they have done much better than residential real estate.

Australian shares produced an average annual return of 9.1 per cent over the past 10 years to December 31, 2012. Superannuation and Australian bonds were the next best performers, returning 6.4 per cent.

Bricks and mortar even struggled to keep up with the 5.4 per cent return on cash. Australian residential property produced a return of only 5.3 per cent.

Property price performance is even worse than it seems, because all returns given in the accompanying table (above, right) are ''total'' returns. Estimates of the gross rental yield coming from rents have been added to the growth in house and unit prices. With shares, the dividends are included in the returns so the asset classes are compared like-for-like.

But the start and end points used to measure performance are crucial to the outcome. The chief economist at AMP Capital Investors, Shane Oliver, points out that 10 years ago was a low point for shares with the end of the ''tech wreck'', and the start of the strong period of returns that ran until late 2007 with the onset of the global financial crisis (GFC).

TIME FRAME

Average annual returns can be lifted or lowered by recent performances, as the performance ''washes'' back through the average. For example, the 9.1 per cent 10-year return on Australian shares has been lifted by shares returning more than 20 per cent in 2012.

Just as the 10-year return on shares starts from a low point, a decade ago growth in property prices was peaking. Oliver says the poor 10-year return on houses and units is influenced by the price boom between the mid-1990s and 2003. But since then, particularly in the key market of Sydney, prices have been treading water, he says.

A financial planner with Paramount Wealth Management, Wayne Leggett, says people try to make comparisons between shares and residential property, but comparisons are difficult. ''The primary appeal of real estate is that it is tangible and investors can tap their knuckles on it and feel good about it,'' Leggett says. But the costs of buying, selling and holding property are high, being a landlord can be onerous, and you cannot sell part of a house as you can do with a shareholding, he adds.

Most of the other asset classes are easily investable. For example, there are unlisted managed funds and listed exchange-traded funds that track or mirror the returns on Australian shares, overseas shares, Australian bonds, and many other financial and commodities markets.

Investors cannot invest directly in residential property unless they have a large amount of money. And the index numbers in the table for property belie the fact that there is a lot of variation in the performance of individual properties, above and below the index returns. ''Property is about location, location, location,'' Oliver says, adding that some property investors will have done much better and worse than the index returns.

SHARES DOMINATE SUPER

The performance of superannuation funds has more to do with the performance of shares than most people think. The typical balanced superannuation investment option, where most people have their retirement savings, has an average annual return of 6.4 per cent (as shown in the table, left). But because the typical balanced investment option has about half its money invested in shares, super balances fell sharply during the worst of the GFC. While the typical super fund has about 20 per cent invested in overseas shares (with 30 per cent in Australian shares), the contribution of overseas shares to the superannuation returns would have depended on the funds' approach to currency hedging.

While overseas shares produced an average annual return of 6 per cent, that was in terms of what is called ''local currency'', meaning the performance of the US sharemarket is measured in US dollars and the performance of British shares in pounds, and so on.

Most Australian investors and their superannuation funds would not have done as well as the return for overseas shares given in the table because of the Australian dollar's rise against the US dollar (and other major currencies) over the past 10 years. In Australian dollar terms, overseas shares have produced an average annual return of only 0.9 per cent. Investment managers can remove the currency effect on returns from overseas shares by what is called ''hedging'' for currency.

Most super funds only hedge their overseas shares by between about 25 per cent and 50 per cent, says the research manager at SuperRatings, Kirby Rappell. Funds usually have the same hedging policy across their overseas share exposures, whether through the funds' diversified investment options or options that only invest in overseas shares.

Rappell says some of the larger super funds offer both a hedged and unhedged version of their overseas shares options so investors can create their own level of hedging.

RISK IS IMPORTANT

Just as important as the return of an investment is the risk taken in getting those returns. Generally, over the long term, the higher the returns the greater risk the investor has to take.

There is danger in simply looking at the long-term performance and investing in the asset class that did best. ''Yes, Australian shares have delivered over the 10-year period but with huge volatility,'' Oliver says. Between November 2007 and March 2009, Australian share prices fell 55 per cent, the worst ''bear'', or falling, market since the 1970s.

The same goes for Australian listed property, the Australian real estate investment trusts (A-REITs). These are the listed trusts that own office towers and shopping centres and which can also carry on property development and construction.

While the average annual return from the property trusts is only 2.5 per cent over the 10 years, those returns have been very volatile.

Before the onset of the GFC in 2007, the sector produced total returns of 32 per cent in 2004, 13 per cent in 2005 and 34 per cent in 2006.

During 2008 it lost 54 per cent when the sharemarket overall lost 39 per cent. And during 2012, the sector returned 33 per cent compared with the market overall, which returned about 20 per cent. Though the volatility of the prices of the trusts is high, the annual income distributed by the trusts to investors, of about 6 per cent, is fairly steady.

Oliver says those with long-time horizons can afford to take more risk and to have higher allocations to shares in their investment portfolios.

He says the shorter the time period and the less the investor's tolerance for risk, the more an investment portfolio should be diversified with assets that are less volatile, such as bonds and cash.

Comparison an exercise in imperfection

The returns from superannuation are better than shown in the table. The reason is that SuperRatings, which provides the superannuation data, reports super returns after taxes and most fees, whereas the rest of the returns in the table are from the relevant market index, which are before fees and taxes. The returns from Australian shares are also understated in the table because the returns do not account for dividend imputation credits. Under Australian tax law, investors receive a tax credit for the 30 per cent corporate tax already paid by the company.

Depending on the investor's marginal rate of income tax, the imputation credits can add up to about 1.5 percentage points to the returns of Australian shares given in the table.

Fees and costs are important in any investment. These compound over time, just like investment returns. That means that while a fee of, say, 1 per cent may not sound like much, it can really eat into returns over time. ''At the end of the day the returns are only part of the exercise,'' says Wayne Leggett, financial planner with Paramount Wealth Management. ''It is all of the other factors like tax effectiveness, liquidity and whether your focus is on income or growth [of capital] or both.'' Someone living off their savings will invest with more importance attached to investment income, whereas someone with a long time before retirement can afford to take more risk and invest more for capital gains. ''These are all things that a planner takes into account to design a portfolio,'' Leggett says.

While the 10-year returns are interesting, who knows what the future holds. Financial advisers say the best investment depends on the person making the investment and what they are hoping to achieve. Is it saving for a house deposit over three years or investing for retirement over 30 years? Is the aim capital gains or income? Is the investor feeling bullish or a nervous Nellie?

The story Returns of the decade first appeared on The Sydney Morning Herald.

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