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Rakhi Vasavada, Financial Advisor

Category: Finance

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Experience: Attorney and Financial Expert. Have specialization in Financial Laws.Practice experience of over 13 years

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I need help understanding the potential returns from two

Resolved Question:

Hello, I need help understanding the potential returns from two different investment options, one being an investment in the stock market and another being in London property. Can anyone help?

Hello and welcome. Thank you for providing an opportunity to assist you.

Yes, I can throw some light on this, however, this is little open ended and both the options have their own pros and cons uniquely different.

however, you have under priced this question and it involves good amount of time. I am making an offer. If you think fit you may accept and we can move ahead.

You must be joking right? £74 I have a simple question about this. What level have I priced at? Here is the question.Say for example I am looking to invest an amount of 200,000 Over a 7 and a half year period the stock market option estimates a return of 90%. That is on the TOTAL return i.e captial growth plus interest.With this option there would be a modest income payment of 3% a year (6,000) in this case.Looking at rental yield alone with the property option nearly all properties rent out at a rate of 4.5% or 5%. This is larger than 3%My understanding becomes blurred when trying to work out how to separate the interest from the 90% Total return. In other words, rental yield may easily beat yearly income from stock investments but how do i work out what the capital growth would look like?So it's really a question about evaluating capital growth on it's own as separate from interest. Thank you

Hello again. In my opinion, these are two investment options that cannot be out-rightly compared. Let me explain. While evaluating such a diverse option, the study of the risk profile of the investor is a must. The reason is, irrespective of the return, the investor will not prefer the capital market option if he has a low risk appetite.

COMING to your question, while talking about the property, you have just counted the yield. You have NOT counted the appreciation (appreciation of the capital value because of anticipated increase in the price of the property). If you combine these two, you will arrive at a decent 40-45% appreciation.

SECOND POINT -- The above option has "certainty" of income. The option of stock market will give you much higher return but it will involve "uncertainty" to a great extent. Also, on need to discount volatility in the returns and they are never uniform.

So far as separating the interest from the 90% return, it is never done this way. While investing in a stock Markets, usually the dividends are reinvested. In the 7 year period, if you sell the stocks at higher price, you will reinvest the profits as well. So, the capital invested will increase by such actions over period of time.

So, the correct method would be to count and take into consideration the start capital of 200,000 and take annualized appreciation into consideration. Interest does not come into picture in any way.

So, a risk-averse or a moderate risk taker will opt for the Property investment option and person with higher risk appetite will opt for stocks.

I am sure this would help.

You may please leave a positive rating if this helps as this is the only way we are compensated for assisting you. Alternatively, you may revert back with a reply if you need further assistance or if I have missed out on any aspect of your question.

This is a great answer, thank you for your detail. I understand that you have the option for a phone conversation. I would happily pay for this to iron out the detail a little more. With the stock market option I have presented the truth is there WOULD be a dividend paid out as a small annual income. This is the 3% The monies would be in an trust fund and investments of 90% over 7.5 years is of course an estimate (the FTSE benchmark is 93.5 but the lower estimate is because it would be an ethical package) Does that mean the 90% total return estimate from that investor has likely assumed that there would be no dividend payments?I understand that property value appreciation is the equivalent of overall capital growth in these two scenarios but property is not exactly easy to predict the growth of either. I'd be interested to know how you arrived at the 40% - 45%

Hello and welcome again. It is pleasure assisting you.

No.. it does not mean that 90% of the total return estimate from the investor has likely assumed that there would be no dividend payments. In fact, from what I have understood from your question is that you have expected the 200,000 to grow by 90% over 7.5 years therefore expecting 12% of Annualized returns. I believe this is little on the higher side UNLESS you have leveraged positions, which the investor does NOT typically have. Correct me if I am wrong.

Secondly, I believe, you cannot expect a 3% dividend payout, therefore DO NOT re-invest it and still expect a annualized return / growth of 12% per annum.

Important, the way you cannot expect / forecast the property to grow 45% in the similar way, you cannot expect such exact growth in the stocks as well. While calculating property returns, I counted the annual yield that you gave me, around 5% per annum plus average compounded 4-5% appreciation in value over 8 years time. So, this was just a rough estimate, obviously not the precise one.

So, if one approximately evaluates these two options, then even the slightly risk averse or a moderate risk taker will opt for property option as the returns are at least certain and relatively less volatile.

Stocks will certainly give you better returns on relative terms but the returns will be volatile and will accompany higher risk element.

Therefore, I am of the opinion that taking the % of returns as secondary, this decision should be primarily be governed with your risk appetite.

I am sure this would help.

You may please leave a positive rating if this helps as this is the only way we are compensated for assisting you. Alternatively, you may revert back with a reply if you need further assistance or if I have missed out on any aspect of your question.

90% divided by 7.5 years is indeed 12%. This 12% annually is the total return from the investment package but assumes all the dividends or income is re-invested rather than paid out annually.As it is a trust fund the package would pay out at 3% a year. For 200,000 this is 6,000 a year. 12% of 200,000 is 24,000 a year in growth. If 6,000 of that is paid out (3% income) that leaves growth at 18,000. That is 75% of the Total return gone. Following this logic (and assuming all the risks as I would anyway) is it logical to think of it like this...Total return - rough income/dividend payments = growth200,000. Total growth of 12% per year, 3% of which will NOT be reinvested but paid out as a dividend. This means annual growth of 9% a year (12% - 3%) So a rough estimate of capital growth after dividend payments would be 9% a year over a 7.5 year period. 9% of 200,000 is 18,000. which over a 7.5 year period is 135,000 growth after dividends.If no dividends and all reinvested 200,000 at 12% over 7.5 years = Total return 180,000 If dividends paid at 3%, 200,000 at 9% over 7.5 years = 135,000 This implies total dividend payment of 45,000 over 7.5 years which matches with my original 6,000 a year (45 / 7.5)So for the stock option return is roughly 9% a year growth and a 3% payout a year.Assuming property value grows 5% a year, and the yield is also 5%This means that by these rough calculations the stock option would potentially be more profitable if 12% per year total growth is to be trusted. The property option may pay out more a year in income but looks like less of a profit.Following all of this i can see that the advise would be that for what is a small-ish gain the risk of the stock market is not worth it! And that property is a safer bet even if you lose a bit of capital in the long run.Does any of this make sense or have i lost you ? :)

Hello again. YES. this very much makes sense. Your calculations / presumptions are more or less correct.

Though your calculation remains very much in line, the only thing that you need to factor in -- is that both of your major components of profits, i.e. dividend payout and the appreciation are "uncertain" variables. This makes the property investment favorable. More importantly, though the stock returns that you have calculated are much superior and very much achievable, you must not forget that for the entire duration / tenure of 75 years, this needs to be "actively managed" and that too successfully. This is not so with your property.

So, slightest of any financial mismanagement of stocks, the returns can decline.

So, as again, as I said in my original reply, let your risk appetite and your ability to actively manage your investments in the financial markets govern the decision making.

I am sure this would help.

You may please leave a positive rating if this helps as this is the only way we are compensated for assisting you. Alternatively, you may revert back with a reply if you need further assistance or if I have missed out on any aspect of your question.

Thank you for your reply Another great response. The stock market route would be managed by an appointment investor - this doesn't necessarily make it less risky but at least it is a professional managing the money.I plucked the 5% property value growth out of the air . So yes there are variables and many assumptions but on the face of it Stock market investment total return 12% a year Property 10% a year But with considerably more risk with the stock market for what could effectively be a 2% gain! Of 200,000 that is 4,000 a year difference which is not to be ignored but I guess what you're saying is ask yourself is it WORTH the risk? ?This all seems to point towards property investment. Finally (and then i will happily rate you 5 stars) although I said there would be an ethical package of investment, this also costs. Property ownership or rental doesn't really have some of the same ethical concerns as some of the markets people invest in.

Yes, you are correct. What you need to decide that for the additional 4000 worth of returns, is the risk really worth ? I would say it is really worth it but again, sticking to my original opinion, I would let your risk appetite decide for it. The core question here is the "class" of capital you are investing. For example, if you are putting in your retirement money, then I would ask you to go for property option without any second thoughts. However, if you have other means of cash and income over and above this 200,000, they you may slightly raise your risk profile and go for stocks.

So, your risk appetite, your current cash flows and other savings / money that you have over and above this will have a significant bearing on what you decide.

I am sure this would help.

You may please leave a positive rating if this helps as this is the only way we are compensated for assisting you. Alternatively, you may revert back with a reply if you need further assistance or if I have missed out on any aspect of your question.

Warm Regards,

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