When you want to invest your hard earned money, there are different financial instruments available. Let us have a look at them and identify the right ones to park your money.
Land & Real Estate:
Land and real estate are considered as the safest assets. Though we have different investment vehicles like stocks, mutual funds, bonds etc, a majority of investors love to park their money in land. The amount of land available in the world is limited and fixed. Hence, there is no question of an increase in supply. As long as there is demand, land prices are eventually expected to go up in the long term. Though there are a lot of benefits in buying a plot of land, we do have a lot of disadvantages. To buy land, you need a bulk amount. In case if you don’t have huge amount of money, you may have to apply for a loan. While there are tax benefits for housing loans, there are no tax benefits for land purchase related loans. Land is illiquid and is not easy to sell. It might take a few months or even years to sell. Whenever there is government takeover, you may not get your full realized value.
Returns over a period of time have been really good. Once an average person starts earning, he generally purchases a land or a house through housing loan. Then he pays EMIs for a long period of time. Let us see real estate returns over a period.
Commercial vs Residential Properties:
Real estate can be further divided into two primary types – commercial and residential properties. While retail investors focus primarily on residential properties, commercial properties deserve a look because of better yield and better capital appreciation.
Be it residential or commercial, location plays a vital role in selecting real estate properties. If the located place is not showing any signs of economic development, properties and land may not appreciate as anticipated. There are so many factors like population, infrastructure, urbanization, Governement’s efforts to grow the state, economic outlook, supply/demand, and economic growth that play major roles in increasing your property’s value.
By keeping your money in these assets, you can only beat inflation. So, you literally retain your earned money without any appreciation. To get meaningful returns, you must invest in inflation beating investments which will help you to have a secured financial future.
Gold:
Gold Price Chart 1900 to 2010
In 110 years, Gold prices have moved from $500 (approximately) to around $1200 in 2010. It went as high as $2200. Overall, it has given a CAGR of % since 1900 which is significantly lower than real estate and equity. Whenever there is uncertainty in economy, gold prices go up. Gold is considered a stable asset. Historically, it was used as a financial instrument before money to exchange goods. Hence, gold can be considered as an option to diversify your portfolio. Gold cannot form a major portion of your investment portfolio. Instead, invest some of your savings in gold.
Fixed Deposit:
Fixed Deposit is a financial instrument that gives an interest rate on amount
deposited. This is considered as a safe instrument to park money. Inflation is always compared with your returns in financial instruments like fixed deposits. Let us see why? Inflation is the general increase in prices that lead to a fall in purchasing power of money. For example, 10 years back, you might have bought 1 kg of apple at Rs. 100, but today it would cost you Rs. 220. When prices go up, your money loses significance. Coins such as 25 paisa and 50 paisa are not available anymore. Hence, you need to multiply your money at a return that is either equal to or greater than inflation. When you add inflation rate, your real returns go down.
Inflation (CPI) vs Fixed Deposit – India (Last 30 years)
Source: www.inflation.eu
Fixed Deposit data is only for SBI
This chart provides you a 33 year comparison between inflation and fixed deposit rates (of SBI, India’s largest PSU bank). In this 33 year period, only in 9 years, fixed deposit rates are higher than inflation rates by more than 3%. If we look at the above graph closely, there was a period between 1999 and 2003 when fixed deposit rates were much higher than inflation for a considerable period of time. But in 14 years, fixed deposit rates are either equal to or higher than inflation by 1%. Hence, when you deposit your money in fixed deposit anticipating good returns, you are actually not getting satisfactory real returns. You are either managing your money to meet inflation or at times, de-growing your hard earned money.
Inflation Adjusted Real Returns thru Fixed Deposits - India
Hence, it doesn’t make sense to invest only in land, gold and fixed deposit. There are other asset classes like bond and equity. Let’s now compare real estate returns against stock market returns.
While looking at returns, we should consider at least one full cycle. It constitutes an economic boom and a slowdown. This gives us a clear picture of how this asset class performed during good times as well as bad times. We are considering the US data here (Fig. 1) as it has a proper history of records of both equity and real estate. If we consider a 100 year history, we can see that both real estate and stocks have performed well. In the long run, land prices are expected to go up. But stock markets have a CAGR of 1.5% whereas real estate has given a CAGR of only 0.2 percent per annum.
Stocks and bonds seem to give better returns but they are highly volatile and risky. In our next article, let’s discuss about reasons to invest in these financial instruments.
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