Buying your first home or buying a piece of jewellery for a loved one is often considered an emotional milestone. While we know that all investment decisions need to be weighed carefully against factors like potential returns, associated risks, liquidity and taxability, these rules don’t seem to apply to physical assets such as gold and real estate. Emotions tend to take precedence over everything else and financial decisions, in such cases, are often made without adequate information, and the myth that nothing can go wrong with real estate and gold perpetuates itself.
The easy availability of loans and higher affordability only feeds this phenomenon further, as it makes it convenient for people to access asset classes like real estate and gold. But this trend is fraught with risks as both these assets are capital intensive. So if you let your emotions dictate your financial life, you could end up with these two asset classes comprising a considerable part of your portfolio. This could result in poor returns over the long term, as well as pose liquidity issues. This is not to say that you should completely junk physical assets; just that you need to understand its place in the larger scheme of things and not acquire more than you need. We help you gain some clarity on the matter.
Knowing the investment product well is the first step to understanding its importance. While you might have seen your share of gold in the form of jewellery, it is important to consider the metal well as an investment product. Gold is a good hedge against inflation but does not give dividend or interest and capital appreciation is linked to the global commodity, oil and dollar cycles—not something an average investor can keep tabs on. Even real estate as an investment is a clunky asset with high transaction costs and liquidity problems. Risks such as the absence of a clear title and encroachments only add to the pain of holding real estate.
Of course, returns from these asset classes also need to be looked at. In the case of real estate, the long-term returns are lower than what the broad market index delivers. In fact, gold is even worse off, having given a lower return (considering transaction charges such as making charges) than fixed deposit over a period of 10 or 20 years. Real estate, in comparison, may have given a slightly higher return, but if we consider the last five years, both these assets have barely beaten inflation, and have therefore given negative returns when adjusted for inflation. These are factors you should take into consideration if you are considering gold and real estate as investment avenues. According to Hemant Rustagi, chief executive officer, Wiseinvest Advisors, a financial advisory firm, it is best to make long-term investments in financial assets like equity mutual funds, since they not only give higher returns than real estate, but also provide transparency, flexibility and tax efficiency of returns.
Besides returns, the other potential downside to investing in physical assets is the concentration risk, given the huge ticket size. “We tend to buy but not sell physical assets. This could result in the allocation to these assets bloating, thereby increasing risks from single asset holding(s)," said Lovaii Navlakhi, managing director and chief executive officer, International Money Matters, a financial planning firm. This goes against the basic thumb rule of investing: diversification.
Further, investments in these assets could also hamper other goals, as you might end up with very little left over at the end of the day to allocate to other things. “Committing a large sum to real estate can result in a shortfall in investment that needs to be made for some of the most important financial goals like your children’s education and your retirement planning," said Rustagi.
While a long-term horizon gives you time for a course correction, a portfolio with a heavy tilt towards real estate could do a lot of damage in case of an emergency. Real estate is an illiquid asset, and even if you do manage to find a buyer, your desperation to sell a property to make ends meet only tilts the balance in the favour of the buyer, who can then haggle down your price. “Higher exposure to a physical asset like real estate can be detrimental to one’s financial future as it can result in a compromise in terms of liquidity and flexibility required in the portfolio at different stages of one’s life," said Rustagi.
Evidently, high exposure to physical assets can do more harm than good. So how much gold or real estate should you have in your investment portfolio? The only way to get the answer to this question is to get your asset allocation right. Start by considering various factors like your risk appetite and financial goals. This will help you realise that gold and real estate can play only a limited role in your financial life. “Physical assets like real estate and gold should have a limited role to play in one’s investment portfolio because of the huge ticket size and liquidity concerns. The key for consistent investment success is to maintain the right mix of physical and financial assets and in the right proportion," said Rustagi.
In fact, according to Suresh Sadagopan, founder, Ladder7 Financial Advisories, a financial planning firm, real estate as an asset class should be the last in line when designing an assets mix for an individual portfolio. This is because it’s a hassle to acquire, maintain and sell real estate. “Real estate is illiquid and the transaction cost and tax bring down the overall return," he said. According to Sadagopan, there is no place for real estate in a portfolio of less than ₹5 crore. However, for someone with a big investment portfolio, allocation to real estate can be between 20-40%. In terms of gold too, planners recommend not more than 5-10% exposure. “A small exposure to gold is recommended as it acts as a hedge against inflation and currency risk," said Sadagopan.
Once you have some clarity, you could financialise your investments. For real estate, this can be done through real estate investment trusts (REITs), and for gold through gold exchange traded funds (ETFs) and sovereign gold bonds. Investing in REITs does not require large sum of money. In fact, the minimum amount of investment to be made in REIT has recently been reduced from ₹2 lakh to ₹50,000. “REITs are certainly a great option for investors looking to diversify their portfolio and benefit from the potential of real estate as an asset class, without having to commit to a large investment, which would be required to buy a physical property," said Rustagi. However, REITs are currently evolving in India and at present there is only one REIT available for investment.
Similarly, buying paper gold through options such as gold ETFs and sovereign gold bonds can be a more tax-efficient way of investing than buying physical gold.
It’s true that investors attach more importance to real estate and gold than they should. If you are among those who have a portfolio with a heavy tilt towards physical assets, it is time to initiate a course correction. While buying that second home or yet another piece of gold can give you an emotional boost, the financial returns are just not worth it.