Purchasing a home or investment property based on short-term market trends can dramatically alter asset allocations and have long lasting impacts on wealth. Here's why.
Owning a home has for decades now been a prerequisite to achieving the Great Australian Dream. While this ideal may be being challenged and redefined as rising prices have pushed affordability further out of reach for first home buyers, Australians still undeniably harbour a strong love affair with property.
Perhaps the term 'real estate' itself is indicative of why we have such aspirations. Real estate feels real – we can see it, touch it, live in it. Unlike the intangibility of shares and bonds, physical dwellings can offer a greater sense of stability and security, and it satisfies one of our basic human needs – shelter.
With COVID-19 the driving force behind sustained record low interest rates, first home-buyer subsidies and remote working in locations far from city centres, the Australian property market, particularly in regional parts of the country, is enjoying a red hot run.
Bull markets, including in property, are bred in part by emotion. It's tempting to follow the crowd – if the average time it takes for regional properties to sell is decreasing and regional home values have surged 6.5 per cent since March last year, then more and more people will start to take an interest in this trend. Perhaps this is best captured by the notion of Fear of Missing Out – which somewhat ironically is what Melbourne City Council is using in its latest marketing campaign to lure folks back into the CBD.
Appreciating that property is a mainstay of many Australian investment portfolios, it makes sense to account for it as a growth asset in your investment plan and asset allocation. While recognising the strengths of property, it is also important to recognise its limitations such as its illiquidity, the cost to transact and the reality that prices do not always go up. Investors can also find themselves unintentionally tilting their portfolio too strongly towards one single asset, bringing with it its own concentration risk.
There's a multitude of factors to also consider before buying a home or investment property, ranging from the ongoing cash required to service a mortgage to the many (and not insignificant) taxes, fees and rental tenant management costs one may encounter over their property-owning lifespan.
There's additionally the risk that interest rates may not stay low forever. While the RBA has indicated rates are unlikely to change for the next three years, most home loan terms extend past that. What will it mean for your mortgage repayments if they do rise in a few years?
Understandably however, the more timely challenge investors are facing right now is that near-zero term deposits are not an attractive investment option. But it is worth remembering that your cash allocation is not only there just for yield, but also to form the defensive part of your portfolio and mitigate investment risks. For example it is common to see SMSF portfolios with relatively high cash holdings as a proxy for fixed interest. So when thinking about residential property be clear about the risks as well as the potential benefits.
Goals, preferences and priorities differ from investor to investor. Wealth accumulation and investment decisions can be deeply personal, just like definitions of the Great Australian dream and what it means to feel secure and successful.
What is applicable to every investor is the need to consider all investment decisions through a long-term lens. Dramatically altering asset allocations based on short-term market trends can have long-lasting impacts on wealth.
To illustrate, we might all be enjoying the perks of working from home right now, but if housing policies change or office life rebounds strongly, will regional properties still be performing their role in your portfolio? The answer lies in your asset allocation.
By Robin Bowerman
Head of Corporate Affairs, Vanguard Australia
06 Apr, 2021