Equities for the long-term

Tom Stevenson
Tom Stevenson
Fidelity Personal Investing6 March 2018

This article first appeared in the Telegraph

Long-run investment performance studies tend to focus on shares, bonds and cash. This is not surprising as the data for these assets is readily available and publications like the Barclays Equity-Gilt Study and Credit Suisse’s Investment Returns Yearbook offer comprehensive and regular analyses of them.

For most people, however, their holdings of financial assets represent only a proportion of their total net wealth. Among the super-wealthy, stocks, bonds and cash account for only about a quarter of their assets. Real estate, including their homes, represents 40%, their businesses another quarter with smaller but significant investments in collectibles like cars, art and wine.

Even for the rest of us who don’t own 1960s Ferraris or magnums of Chateau Lafite, non-financial assets (principally our homes) can be a significant slice of our wealth. In a country like the US, where houses are relatively cheap and stock market investment a part of the culture, Credit Suisse estimates that 77% of wealth is held in financial assets. In China, by contrast, the world’s most valuable real estate market with owner-occupancy of 90%, only 45% of wealth is held in financial assets. Here in Britain we’re in between, with 56% in financial assets and 44% in non-financial, mainly our houses.

Dividing our wealth between different asset classes makes sense from the perspective of risk diversification and there are also non-financial reasons to put our eggs in a variety of baskets. For those who can afford to do so, the typical ultra-high-net-worth individual’s asset allocation is prudent. But the argument for owning property, let alone rare books or jewellery is less clear cut from the numbers.

The long-run evidence suggests that we are right to weight our investments towards financial assets. An investment of £1 in the UK stock market in 1900 was worth £566 by the end of 2017 even after accounting for inflation, according to Credit Suisse and the London Business School. Over the same period, the real appreciation in house prices in Britain has been just seven-fold. Even in the best-performing property market since 1900, Australia, houses have only grown 13 times in inflation-adjusted terms. In America, they have held their real value but not much more.

For the so-called passion investments, the average real return over the past 118 years has been a bit better than bricks and mortar but the 30-fold increase in the likes of classic cars, violins and wine pales into insignificance compared to the returns from equities.

Of all these alternative investments, property is the most significant, because it is so widely held and because it accounts for so much of the world’s accumulated wealth. Even stripping out the value of commercial real estate and agricultural land and forestry, residential housing is worth around $170trn around the globe. That’s pretty much exactly the sum of all the outstanding bonds ($100trn) and equities ($70trn). By contrast, all the gold that’s ever been mined is worth just $6.5trn.

But, contrary to the widespread view among today’s baby-boomers and their envious children that houses have always been a money-making machine, their real appreciation is a relatively recent phenomenon. For the first half of the 20th century, pretty much everywhere, houses acted as a hedge against price inflation but offered no real investment returns.

There are a few possible reasons for this. In the early years of the last century, improving transport links massively increased the supply of accessible land and so kept a lid on prices. This process stopped in the second half of the 20th century while more onerous planning regulations pushed up the price of land. More recently, super-easy monetary policy has boosted the value of all assets but particularly those that typically are bought with the assistance of significant amounts of borrowed money.

There are a number of problems when comparing the returns from houses and equities. The first is that the indices used to measure house price changes have only a limited bearing on the actual experience of an individual home-owner. To be more representative they would need to be adjusted for their historical bias to big cities as well as for the hidden costs of home-ownership, maintenance and particularly for long-run improvements in quality (since 1900, heating and indoor toilets to name just two).

The second adjustment required to ensure we are not comparing apples and pears is rent (either real in the case of a buy to let property or imputed for an owner-occupied home). The third variable is risk. Property is not quite the safe as houses investment it might seem. Real house prices in America fell by 36% between 2005 and 2012 and they are still below their peak.

I’ve already hinted at the final factor that any ‘pension or property’ comparison needs to take into account - leverage. Anyone who buys a house with a 10% down-payment and a big mortgage is taking the kind of risk that only the most aggressive hedge fund would consider in the financial markets. For the vast majority of home-owners it is a risk that has paid off in spades. The value of my house today represents a breath-taking return on the £3,500 I put down on my first flat 30 years ago.

What any purely financial analysis of the performance of shares, houses and passion assets cannot begin to account for is the psychological returns they provide. Fine art feeds the soul, a home offers security, good wine is a gift. They provide a healthy mix of wealth preservation, diversification and pleasure. But shares have long provided an outsized reward for the risk of short-term volatility and they should account for the lion’s share of a long-term portfolio.


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