The property market may be flat in many parts of Australia, and shares have leapt around a fair bit in recent weeks. But a report issued this month confirms that shares and property scoop the pool when it comes to long term returns.
The ASX and Russell Investments Long Term Investing Report highlight the performance of various Australian and overseas investments over the past 10 and 20 years. It also reveals the impact of income tax on returns, which is important because investments aren’t all taxed in the same way. The interest earned on cash based investments for instance, is fully taxable whereas shares and property both offer tax breaks.
According to the report, the highest gross (before tax) return of the studied asset classes over the 10 years to December 2011 goes to residential property, which earned an average annual return of 8.0%. For a high income earner, this translates to an after tax return of 5.8%, or 7.2% for an investor on the lowest personal tax rate.
Interestingly, Australian bonds scored the second highest gross return over the period of 6.4% annually. But there’s a catch. The after tax return for a high income earner was 3.3%, showing just how significant the tax take on interest bearing investments can be.
Australian shares dished up a gross annual return averaging 6.1% over the last decade. Here again though the numbers look quite different when tax is considered. For an investor on the top personal tax rate, the after tax return would have been 4.6%, considerably higher than for bonds.
Low income earners would have fared even better. Our system of dividend imputation gives shareholders credit for the tax already paid by companies on the profits from which dividends are distributed. In the case of ‘fully franked’ dividends, this is effectively after 30% taxed money, in your hands. So an investor on the lowest personal tax rate would have earned an after tax return on Australian shares of 6.5%. I reckon it shows that you don’t have to be a high income earner for shares to be a worthwhile investment.
At the lower end of the scale, cash – and this includes savings accounts and term deposits – returned 3.8% per annum. When you consider that inflation over the 10 year period was 2.9%, it’s a pretty unexciting result. For a high income earner, the after tax return on cash would have been just 2.0%, meaning those investors would be going backwards in real (after inflation) terms.
Over the last 20 years, there was not much between shares (8.7%) and residential property (9.0%). After taking tax into account, shares topped the returns for both low income earners (9.0% versus 8.1% on property) and high income investors (7.0% compared to 6.6% for property).
This study confirms the value of investing in growth assets like shares and property. Sure, the market for both assets can, and does, experience short term falls, and that’s why they should be seen as long term investments. Ideally, any shares or property should be held for around ten years to even out the market highs and lows.
Cash investments are very secure, but the price you pay is low long term returns. This is a serious downside to having a large chunk of your wealth tied up in savings accounts or term deposits for extended periods.