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What are the factors you must consider before investing?
Whenever you are investing, you should look at five variables about any investment. What is the risk? Can you lose your capital or your capital is going to be largely protected? Can it never go down in value or will it go down in value? Can it go down in value temporarily or if it goes down in value, can it go forever? Things like that. So, what is the risk and why? Then comes the return. How much will you get for the risk that you're assuming. Generally speaking, if the risk is low, then you tend to get a low return. If the risk is high, then sometimes you are likely to get a high return, but the downside is that risk is high, which means once in a while, you will also lose your money. Then comes liquidity. In case of need, how soon can you realise your capital that you have invested. Then comes the taxability of it. Whatever return that you realise from that investment, how will it be treated? Will it be treated as income? Will it be treated as capital gain? Accordingly taxation rates will apply. Then comes one most important thing is its ability to beat inflation. There are investments which can beat inflation. They're designed in a manner that they can beat inflation. So these are broadly five variables which you should look at.
But one of the most important things is the ticket size - what is the amount of money that you need to participate in that. For example, when it comes to mutual fund investment, you can start your SIP with Rs 500. But if you want to buy a gold ETF or bonds, then the minimum unit of a gold bond is the worth of one gram of gold. Or likewise if you have to buy a house, the minimum ticket size could be anywhere from a few lakhs to many lakhs or few crores. So you have to really decide what fits in your scale of things and plan accordingly.
What are the pros and cons of investing in real estate?
There are different ways in which you can invest in real estate. One is that you can buy a piece of land or you can buy a flat, or you can buy a real estate investment trust (REIT). It's a financial instrument, where when you buy a mutual fund, the mutual fund invests in stocks or shares or bonds. Here is a fund which buys real estate and it has two kinds of income. One is that fund which holds the real estate, it can sell those assets. And if it does not sell, then the commercial real estate is normally yielding a good rental. So that is your earning, that is what you keep getting on an ongoing basis. And once in a while, the fund will sell those assets and that capital value realised will be much more than what it was paid for. So that will be your gain. So that is how real estate investment trust works.
Now coming to is it a good investment or what are the pluses and minuses of real estate as an investment? I'm talking of the real estate investment that you make if you buy a piece of land or buy a flat. One biggest advantage is the emotional comfort of living in your home. Then second is to be able to save on the rent that you would have otherwise paid. And third is that you get some tax break on the interest component of the home loan repayment that happens.
The biggest disadvantage is that normally the ticket size is very different. If you want to invest in a mutual fund, you can do it with Rs 500 a month SIP. If you want to do your recurring deposit, you can do it with any similar kind of thing. But when it comes to buying a house, it will be a big ticket thing - it will be a few lakhs to a few crores and you end up borrowing money for that, and that is why you incur interest. Second is that, if you hold a real estate and you are not living in it, if you have a property, then you have to make sure that you continue to possess it and somebody else is not actually abusing it, misusing it or capturing it. It is not a financial investment. Only one component, real estate investment trust is a financial investment, but real physical real estate, if that, if it is real then you have to take care of it, and worry about it and make sure that nobody steals it or nobody abuses it. Third is liquidity - you can't realise money at will. If you have invested your money in this house, and suddenly you need that money, can you get it in 48 hours? No.
What are the pros and cons of investing in mutual funds?
The real disadvantage of a mutual fund is that you incur an expense. Besides that many categories, all equity linked investments are reasonably volatile. Sometimes the long-term bond funds can be subject to decline in value, which most people are not used to. You invest in a bond fund, and it goes down in value simply because it has invested in long-term bonds. And if the interest rate goes up, they go down in value. So, many investors have to reconcile with the steep ups and downs of these funds.
One of the biggest advantages of mutual funds is the realisability. Whenever you need it, you can get it in anytime - sometimes, some funds provide your overnight realisability. You invest in a liquid fund, you get your money the next day. You invest in an equity fund, it is T + 3, so the day you redeem it before 3:30pm, you will get your money in two days' time. So your ability to get your money back and more so in times of urgent need is very much possible. Besides that you can borrow against a mutual fund. You don't necessarily need to sell it, assuming that you need money for a small period of time, you can mortgage your fund and get your money in about anywhere between half an hour to two hours. The whole process is now digital. Many people provide this service. So that is another advantage. So realisability and ability to have money against that.
Where should you invest - real estate or mutual funds?
Which one to choose? I don't think it is a matter of me advising you what you should choose. If you want to buy a house, that's a different decision. If you want to invest in a house, that's a completely different decision.
I would say that most people should buy a house, if 1/3 of their income can go into paying repayment of that EMI - the money that you will borrow against for buying that house. If you can do that and if you're incurring rental expense, if you're spending money on paying the rent, then you should consider buying it and it is not an investment for now or your life till you think in terms of selling it and upgrading yourself to another house, it is not an investment. It might go up in value is a different story. It's your home where you live. Then comes the second home or the one which you will buy just because its value will go up and then you will sell. That is your investment. Based on this, I would suggest that buying the second home situation arises only when you come across a special situation - you come across a house which is being sold, somebody is desperately selling it and in this desperation you're able to strike a great bargain. Maybe you should consider buying that. But except for that, all kinds of disadvantages - maintaining it, keeping an eye, making sure that you have the time and inclination and resources to keep it alive, keep it well maintained, well-kept and looking for a tenant and doing the documentation and not worrying about it. Then you have that big ticket of investments with which you can make one investment. So that's a disadvantage.
If you want to keep it very simple, realisable, optimally growing, then choose a mutual fund. It is very simple.
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This article was originally published on September 11, 2023.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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