Although many investors place a heavy emphasis on the stock market, real estate has been the most favored long-term investment of Australians. The findings come from a survey of an independent, nationally representative panel of 1006 Australians commissioned by online finance information platform Money.com.au.
We all have super so we invest in stocks indirectly. Also, millennials are very active in stocks as an entry point for investment. Clearly the stock market offers several advantages, including easy access, low investment opportunity and high liquidity. Conversely, real estate – particularly private market real estate – offers benefits not found in the stock market. Real estate is less volatile than stocks.
These differences often make real estate investments complementary to investment portfolios providing meaningful diversification among other benefits.
Examining the volatility of the stock market helps to understand one of the major differences between the markets in which they’re traded.
Volatility and correlation within the stock market
Volatility and correlation exist in every investment. These two measurements are key in examining the distinctions between public and private markets, because their differences illustrate the advantages and disadvantages of each market type.
- Correlation is the measurement of the degree to which investment performances are related to one another. Investments can have positive, negative, or no correlation with one another. In general, the more investments you hold with little or no correlation, the more diversified your portfolio is.
- Volatility can be reduced through diversification. This diversification can be achieved by choosing investments with little or no correlation with one another. When volatility is properly diversified, a portfolio has a lower risk of loss in the event of poor performance. This is why super funds balance higher risk stocks with blue chip stable stocks.
As important observation here is that Covid has defied logic for many commentators as an external risk – the predictions of doom and gloom for stocks and property.
Volatility and correlation within the private market
- Each market has risks and they are different between the private and public markets, which helps make the investments complementary for the purpose of diversification.
- For example, a rise in inflation would likely cause many asset classes to rise in price, making it more expensive to earn the same return potential. Even though the value of the asset would increase, it would mean that any earning potential would become more expensive.
- While the price of an investment rises to keep pace with inflation, some assets, known as hard assets – typically include precious metals, commodities, natural resources, and real estatecan outpace inflation. Hard assets are well suited to hedge inflation because they hold intrinsic value because they are re naturally limited in supply. This intrinsic value gives a hard asset its ability to keep pace with – or exceed increases in inflation.
- As land becomes scarcer, especially in high-demand areas, its value appreciates. Real estate also holds the unique ability to capture the value of its scarcity through both appreciation and income, because both can rise with demand.
- An increase in inflation is just one example of an event that would likely cause volatility throughout most, if not all publicly traded investments. A forecasted or real increase in the federal interest rate increase would also cause many asset classes to decline in price. Conversely cash invested – term deposits – is negatively impacted when rates decrease. This is because a higher interest rate would make loans more expensive for both businesses and consumers, which would likely reduce spending from both.
- Private market real estate – like other investments – is subject to its own set of risks as well as those inherent to the entire financial system. However, unlike other asset classes, it offers useful ways to manage some risks in a way that other investments can’t.
Why aim for low correlation and volatility?
Portfolios containing investments with little or no correlation have much less risk of volatility and, ultimately, loss. By diversifying a portfolio across uncorrelated assets, an investor can take the least amount of risk necessary to earn their target return in the most stable way available.
Also, if your portfolio holdings are spread across uncorrelated assets, the strong performance of one or more investments could mitigate losses in your portfolio when another asset underperforms. This is because uncorrelated assets are far less likely to lose value in tandem than correlated investments.
Many have diversified portfolios – super and real estate. However, it is useful to understand how diversity works for good investment as private and public markets have their own challenges.