A million dollar question – Should you invest in property or bank deposit?

Should you save your money in bank and earn interests, or invest in property and earn capital gain? This may be the question you have been asking all the time. The objective is simple, that is to create a passive income – your money is added even when you are sleeping – so that you do not have to work for the rest of your life and ensure your days after retirement. Some say that money should be deposited, and let the money grows through interest rates. However, it cannot be denied that investing in property has become a seriously attractive investment as theoretically, the price of land will never go down, in other words the price will keep increasing FOREVER. In order to decide which type of investment is suitable, one has to understand the advantages and disadvantages of each option, as will be discussed below.

BANK DEPOSIT

Benefits:

  • Minimum Risk: in comparison to the property investment, depositing money in banks is a much safer investment. Money in the deposit will keep increasing as long as the interest rates are positive. Now you may be wondering whether or not interest rates can turn negative. The answer is YES. Fujioka (2016) reported that Bank of Japan kept the interest rate at negative 0.1 percent to encourage cash withdrawal which to be spent on market, and subsequently tackled the deflating economy. Shall central banks in your country exercise quantitative easing (a monetary policy of reducing cost of borrowing in order to encourage spending) to the point where interest rate is below zero, then your money in bank deposit will start gradually declining.
  • Compounding interest: your deposit will grow significantly in the long-term. For instance, given that the interest rate of bank deposit for the next 10 years remain constant at 5 percent. Money deposited in the beginning of the year is $1,000,000.00. In the first year, the interest revenue is $50,000.00 (5% x $1,000,000.00). It will then be accumulated to the nominal value. Nominal value + interest revenue Year 1 = $1,050,000.00). On the second year, the interest will be calculated based on the accumulated amount ($1,050,000.00). Long story short, the interest revenue earned at the end of year 10 is $77,566.41, an approximately 55 percent increase in interest revenue from the first year. Over longer period of time, the interest revenue alone would be sufficient to finance luxurious lifestyle.

Limitations:

  • Negative rates: As mentioned previously, bank deposit is not out of threat because as soon as Central Bank sets negative interest rates, then your nominal in the bank deposit will be gradually decreasing.
  • Slow Investment: Return on investment of bank deposit is lower than property investment. As a relatively safe-type-of-investment, the rate of return of bank deposit is lower than other types of investment. It is consistent with the concept in finance: higher risks = higher return. Due to its nature, bank deposit is not appropriate for investors who seek maximum return.
  • Real Return is lower: The value of money declines as inflation increases. Inflations need to be considered when calculating the real return of the investment. For example, the price of avocado is $3. A year later, the price increases to $3.5, a 16.67% increase. This scenario shows that the value of the money has declined, a situation where extra money is required to acquire the same product. In the real economy, the inflation – the general price increase – will thus reduce the value of your money. For example, the interest rate of bank deposit is 6% per annum and the inflation rate is 2%. Hence, your money only grows for 4% in the real term.

PROPERTY INVESTMENT

Benefits:

  • Continuous price increase: As the value of houses grow, so thus your money where you can obtain profit through capital gain.
  • Additional income: through rent (the money can be used to pay the property’s mortgage)
  • Inflation: The price of house will generally increase as the inflation increases.

Limitations:

  • Financial constraint: It may not be suitable for those will limited financial capability.
  • Legally: requires certain legal matters. For example, one who happens to have money but has never worked before, and thus never filled tax formed, may need to disclose the source of money in the bank account. This can be a potential constraint or reason why one decides not to invest in property as it requires the person to disclose information associated with his or her assets. This situation normally occurs in the countries where tax avoidance rates are high.
  • Price crash: Although theoretically the price of house will never fall, in the real world it may happen. The matter of fact, it happened in 2008 within the United States of America where the house pricing bubble burst and crashed which consequently decrease the house prices dramatically. Another survey shows that the price of houses may not be increasing all the time. The graph below show the changes in house prices in the Indonesian market. Hence, it can be concluded that investing in property markets is not risk-free, and thus expose investors onto certain uncertainties and threats.

Understanding the advantages and disadvantages of every investment, one should be able to decide which type of investment is suitable for each individual, depending on preferences. You are recommended, however, to invest in both, in order to diversify the risks. The rule of thumb is that save money to the point where the interest revenue is high enough to fulfill daily needs and wants. The leftover can then be invested in a more risky type of investments, such as in the property or equity markets to earn higher returns.

What to watch:

  • Supply and demand for property. Housing price bubble was led by over-supply which lead to over-price
  • Inflation and growth rates: Central Bank normally sets interest rates based on the inflation rates. When the inflation and growth rates are high, Central Bank will often exercise quantitative tightening (increase interest rate), and vice versa.
  • Interest rates: matters for savings, but also mortgage rates.

References:

Fujioka, T. (2016, September 21). BOJ shifts policy framework to targeting Japan’s yield curve. Bloomberg. Retrieved on July 17, 2017, from https://www.bloomberg.com/news/articles/2016-09-21/boj-shifts-policy-framework-to-targeting-japan-s-yield-curve

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