Why Equity Funds Don't Beat Real Estate

In India, the one asset class that everybody loves to hate is equities, and the one investment that everybody loves with a mad passion is real estate. Try to argue with this perception, and you get loads of hate mail. Promptly, many investors write in saying how they've made only losses on equity funds but have raked in fabulous returns on real estate.

So, why do Indian investors have such a good return experience with real estate and such a poor one with equity funds? After all, both are very similar assets that tend to boom or slump with the economy. Here are a few explanations.

Too much churn
Going by the point-to-point returns on equity funds over the last five or ten years, it is quite difficult to see how any investor could have lost money if he bought an equity fund and simply held onto it till date.

Even the worst diversified equity fund has delivered a ten-year CAGR of 10 per cent and the best one is at 20 per cent. But most people don't make this return in practice because they try too hard to 'time' their equity investments. When equity markets are booming, they invest large lump sums or start SIPs in equity funds in the hope of high returns. When equity markets slump, not only do they struggle to retain the conviction to continue SIPs, they even get tempted to pull out.

Thus, the investor experience with equity funds tends to be poor because people view funds as an opportunistic investment - they invest when markets are peaking and usually exit when markets are low.

If they did the same with real estate, they would make losses. But the truth is that they usually do the opposite with real estate. First, you don't try to time your property purchases when prices are zooming. You buy property when you feel the need. Nor would you rush to dump your property when the market is in a downturn. If there's a downturn on, investors would wait to get a better price for it.

What aggravates this behavioural bias against equity funds is that with these funds you can actually track your everyday returns. When you see your equity fund NAV sinking by the day, it's hard not to act and get rid of the fund. With property, unless you make a transaction, you don't get to know how much prices have fallen. So you have the conviction to hold on through a downturn.

Too small to matter
The second reason why no one ever seems to have become a millionaire investing in equity funds (while they do with property) is that they simply don't invest enough.

Ask people around you what sums they are investing in equity fund SIPs - you'll find sums like ₹1,000, ₹2,000 or ₹5,000 being bandied about. But ask about their home loan EMIs and the big numbers come tumbling out. They're committing ₹25,000, ₹50,000 or even ₹70,000 on their property investment, a good portion of their monthly pay cheque. How can an SIP investment of ₹5,000 a month match up a ₹50,000 EMI? If you invest less, you are bound to make less.

Power of leverage
That's not all. When we buy property, our conviction in the asset is so strong that we are willing to leverage our savings to make a really big bet on this one investment. Therefore, if you have `20 lakh worth of your own savings, you're willing to take on a ₹80 lakh home loan and pay a monthly EMI of ₹88,000 so that you can buy a ₹1 crore flat.

You may not notice it. But by committing ₹88,000 a month over a period of 15 years, you're actually investing ₹1.54 crore in that flat (considering both your interest and principal repayment). If the value of that property rises fivefold to ₹5 crore by the time you pay off your loan, you are mighty pleased. That's a sum that can make a big difference to your wealth!

In contrast, people seldom take loans to make equity-fund investments (it's not a great idea anyway). So if you continue with a ₹5,000 SIP for 15 years, you would have invested a mere ₹9 lakh. At the end of the period, you'll be left with ₹33.4 lakh even at a 15 per cent CAGR. That won't seem like much, simply because the investment you made is one-twentieth of the sum you had invested in the flat.

No like-to-like comparison
A final reason why most people believe they've scored big with real estate but not with equity funds is that they don't really compare the returns from the two assets on an annualised basis. If a `1 crore flat appreciates to `5 crore in 15 years, people think it's a fabulous return. But for the record, that's just an 11.3 per cent CAGR.

Now, if an equity fund reports an 11.3 per cent CAGR over 15 years, people will write it off as a laggard, because they expect equities to earn a much higher return.

Overall, maybe what you need to do to earn a real estate-like return from your equity funds is the following:

1. Buy your equity funds when you have sufficient savings and not when the 'time' is right.
2. Sell them only if you need the money or your goal is met.
3. Don't be stingy with your SIPs. Think of the terminal value that can make a big difference to your wealth and back-work to get to your SIP amount.

Don't redeem your fund just because you think its relative returns (compared to the top fund or the category) are low. As long as it's beating your other investments over the long term, it is good enough for you.

This article was originally published on August 13, 2015.