How to actually buy a house

How to actually buy a house

Buying a house is a necessity but a difficult investment decision to make. Here's what to keep in mind


Of all the big investments you are likely to make, none is so fraught with uncertainty and doubt as that of buying a house. For once, this is not the fault of the saver. The blame lies squarely with the way the real estate industry has evolved over the last decade or two. The very idea that a house is a financial investment is a product of the hype that has evolved over this period. Before that, except for a handful of people who had vast amounts of cash to utilise, houses were not financial investments. Of the small number of Indians who were prosperous enough to actually buy a house, most just bought one in which they lived out their years and on which their children later litigated.




However, starting around the year 2000, the combination of dropping interest rates, tax breaks, and rapidly increasing disposable incomes reached a tipping point. This led to the rise of the EMI investor, the small, leveraged second (and third, and maybe fourth) homebuyer which was something that India hadn't seen before. People took loans to buy houses and sold them two or three years down the line because prices had risen enough to prepay the loan and still make an enormous profit. However, the real estate industry rapidly rigged this phenomena and turned it into a bubble which eventually burst. While that's a long story and this is not the place for it, today there are any number of people who are stuck with unbuilt houses with unpayable EMIs.


None of this is a secret. The only problem is that real estate cheerleaders-which include builders, dealers, and the media, which is beholden to real estate advertising revenues-are fully dedicated to convincing you that none of this is happening or if it is, then a huge revival is just around the corner. However, you still must try to buy one house. Despite all of the above, real estate is the only purchase for which it's fine to take a loan. The saving on rent, the tax break, and the psychological comfort are worth it.
However, you have to ignore the hype and stick to these principles:

One, buy just one house which will actually save you rent. Do not even think of buying any more just for investment.


Two, and this is the most important rule-don't stretch yourself. No matter how much you'd love a fancy house and how beautiful the ads and the brochures are, the EMI should not be more than one third of your family income. That's the UPPER limit. If you can get by at a lower level, then please do so. Basically, don't buy a house of your dreams. I know that the whole thrust of real estate marketing is this 'house of your dreams' concept, but that's a really bad way to make a sensible choice.


Three, I hardly need to point out that there's a huge difference between a house and a promise of a house. Completion of projects is at a premium today. This is unfortunate, but is a side-effect of the way real estate developers have gotten away with fraudulent behaviour. So, buy something that you can live in, rather than a mere plan and a promise.


Look at it in another way. Real estate investments must be evaluated in the normal terms of any investment - liquidity, safety, transparency, returns and similar parameters. Most people get confused about this because there is a fundamental difference between your first house where you live in and property bought purely for investment. The first house is a need and when you take into account the fact you can stop paying rent and get a tax break on the EMIs, you'll get a big financial advantage. In any case, a first house may or may not turn out to be an investment; it doesn't matter.


The myth of real estate being a great investment is mostly due to mathematical illiteracy about compound growth. Any real estate fan will tell you how some land or house became 50 or 100 times its value in 40- 50 years. Sounds fabulous, but you know, the BSE Sensex has become 300 times its value in 38 years. That's Rs 10 lakh becoming Rs 30 crore. Even 100 times in 50 years, which is a real estate example someone from Mumbai gave me, is a 9.6 per cent per annum gain. That's a good return, but not an outstanding one in India. It's certainly a lot less than stocks.


After that, there is basically no case for real estate as an investment. The ticket size is huge, liquidity is poor. The entire investment has to be sold at one go. You may or may not be able to sell when you want to-in a slump, entire markets disappear for long periods. Pricing may be hard to discover. Information is anecdotal and hard to verify.
The choice is clear.

 

Happy Investing

Source:Valueresearch.com

Please read this document carefully before investing. No, really

Please read this document carefully before investing. No, really

The standard mutual fund disclaimer is true but not very useful. Many years ago, an American fund manager wrote a very different one which was more useful

This week, I'm going to write very little and instead just quote fund disclaimers. Here's the standard disclaimer from an Indian mutual fund that you must surely have seen: Mutual fund investments are subject to market risks. Please read the scheme information and other related documents before investing. Past performance is not indicative of future returns.






And here's the equivalent statement of an American fund from around the year 2000, which I found via the blog of Jason Zweig, who writes wonderfully about personal finance in Wall Street Journal. Without further comment, with some editing for length:



First of all, stock prices are volatile. Well, duh. If you buy shares in a stock mutual fund, any stock mutual fund, your investment value will change every day. In a recession it will go down, day after day, week after week, month after month, until you are ready to tear your hair out, unless you've already gone bald from worry. It will insist on this even if Gandhi, Jefferson, John Lennon, Jesus and the Apostles, Einstein, Merlin and Golda Maier all manage the thing. Stock markets show remarkably little respect for people or their reputations.



While the long-term bias in stock prices is upward, stocks enter a bear market with amazing regularity, about every 3 - 4 years. It goes with the territory. Expect it. Live with it. If you can't do that, go bury your money in a jar or put it in the bank and don't bother us about why your investment goes south sometimes or why water runs downhill.



Aside from the mandatory boilerplate terrorizing above, there are risks that are specific to the IPS Millennium Fund you should understand better. Since most people don't read the Prospectus (this isn't aimed at you, of course, just all those other investors), we thought we'd try a more innovative way to scare you.



We buy scary stuff. You know, Internet stocks, small companies. These things go up and down like Pogo Sticks on steroids. ... While we try to moderate the consequent volatility by buying electric utility companies, Real Estate Investment Trusts, banks and other widows-and-orphans stuff with big dividend yields, it doesn't always work. Sometimes we get killed anyway when Internet and other tech stocks take a particularly big hit. The 'we' is actually a euphemism for you, got it?



Received Wisdom can turn on a dime in this business, and when that happens prices fall off a cliff. Even if we were really smart and stole these companies, if their prices run way up we are still as vulnerable as if we were really dumb and paid that high a price for them to start with. ... Just so you know. Don't come crying to us if we lose all your money, and you wind up a Dumpster Dude or a Basket Lady rooting for aluminum cans in your old age. Please e-mail us if we haven't scared you enough, and we'll try something else.



Both the above disclaimers--the dull Indian one and the funny American one--are equally correct, of course. However, only one of them is actually useful in communicating any kind of fundamental truth about investing. No prizes for guessing which one. Of course, no prizes also for guessing that the American fund which issued this disclaimer never managed to collect much money from investors. After all, telling the plain, hard, uncomfortable truth is so unusual in the financial services business that investors wouldn't really have responded to this kind of a statement.



But the truth is that if you invest in equities or equity mutual funds, then you should print out this disclaimer and pin it up on a board. There are two aspects to what it says.


Both are summed up in the sentence 'While the long-term bias in stock prices is upward, stocks enter a bear market with amazing regularity, about every 3 - 4 years'. Every equity investor must take this to heart.


Happy investing
Source:Valueresearch.com

How to buy a mutual fund

How to buy a mutual fund

If you are planning to start investing in mutual funds, here's a complete guide

What you need to get started with Mutual Fund investing?
To start investing in a fund scheme you need a PAN, bank account and be KYC (know your client) compliant. The bank account should be in the name of the investor with the Magnetic Ink Character Recognition (MICR) and Indian Financial System Code (IFSC) details. These details are mentioned on every cheque leaf and it is common for an agent or distributor to seek a cancelled bank cheque leaf.

How to get your KYC?

The need for KYC is to comply with the market regulator SEBI in accordance with the Prevention of Money laundering Act, 2002 ('PMLA'), which undergo changes from time to time.
KYC process is investor friendly and is uniform across various SEBI regulated intermediaries in the securities market such as Mutual Funds, Portfolio Managers, Depository Participants, Stock Brokers, Venture Capital Funds, Collective Investment Schemes and others. This way, a single KYC eliminates duplication of the KYC process across these intermediaries and makes investing more investor friendly.
Documents required to be submitted along with KYC application

• Recent passport size photograph
• Proof of identity such as a copy of PAN card or UID (Aadhaar) or passport or voter ID or driving licence
• Proof of address passport or driving license or ration card or registered lease/sale agreement of residence or latest bank A/C statement or passbook or latest telephone bill (only landline) or latest electricity bill or latest gas bill, which are not older than three months.

You will need to submit copies of all these documents by self-attesting them along with originals for verification. In case the original of any document is not produced for verification, then the copies should be properly attested by entities authorised for attesting the documents. In case you are unable to furnish proper documents, it could result in delays in getting a KYC.


Resident Indians can get it attested by: Notary public, Gazetted officer, Manager of a scheduled commercial or co-operative bank or multinational foreign banks. Make sure the name, designation and seal is affixed on the copy.


NRIs can get attestation from: Authorised officials of overseas branches of scheduled commercial banks registered in India, notary public, court magistrate, judge, Indian Embassy in the country where the client resides.


How to check your KYC status?
Existing investors and those who have submitted their applications can check the status on KYC compliance with their PAN number with any of the KYC Registration agency

• https://www.cvlkra.com/
• https://kra.ndml.in/
• https://www.nsekra.com/
• https://camskra.com/
• https://www.karvykra.com/

Mutual fund application form
Each mutual fund scheme has a form that investors need to fill. If you start investing in the systematic investment plan (SIP), you need to fill in two forms: one to open an account with the mutual fund and the other to specify your SIP details such as frequency, monthly instalment amount, and date on which the SIP sum is to be invested.


Investing for Minors
If you wish to invest in the name of a minor, you need to fill in a third-party declaration form.

• Only parents are allowed to invest on behalf of their children
• Documents that establish the parent's relationship with the child should be submitted (Passport, birth certificate or any other ID proof)
• If the child has no parents in case of an eventuality, then a court-appointed guardian can invest if necessary documentary proof is submitted to establish the relationship between the minor child and the guardian

Growth, Dividend or Dividend Re-investment
When investing in mutual funds, there are three options that are available in which you could invest: growth, dividend and dividend reinvestment. One is normally expected to select one of the three options when filling an investment form, however, in case if you do not fill any of the option, the fund house selects the default option for the scheme as mentioned in its Scheme Information Document (SID), which is most often the growth option. Investors have the flexibility to change the investment option at a later date to suit their convenience.


Growth option: In this option, the scheme does not pay any dividend, but continues to grow. Therefore, nothing is received by you as a unit holder and hence, there is nothing to reinvest in the scheme. Any gains made by selling the fund holdings are invested back into the scheme, which can be seen in the NAV (net asset value) of the scheme, which rises over time. But, the number of units with the investor remains the same.
Dividend payout: In this option, the mutual fund scheme pays you from the profits made by the scheme at regular periods which could be monthly, quarterly, half-yearly or yearly in case of debt funds and at irregular intervals in case of equity funds. A liquid fund also provides for a daily or weekly dividend option. However, you should be aware that dividends are not guaranteed, which means a fund is not bound to pay out a dividend; it may or may not pay a dividend.


Dividend reinvestment: In this option, the dividend is not paid to you, instead it is reinvested in the fund scheme itself by buying more units on your behalf.
Each of the three options has its share of pros and cons, which will vary depending on your needs. As investors, the treatment of gains and taxes are the two essential features that differentiate these options. If evaluating the returns from an investment at a point of time, there is no difference among the three options. The difference emerges in an implicit form with respect to the applicable taxes.
Further, it is important to consider the tax impact when selecting between the growth, dividend payout or dividend reinvestment options as the post-tax returns' differs between the options. This difference occurs because, the tax treatment is different for long-term and short-term holding period. The tax treatment also differs for equity and debt funds.

Capital Gains from Mutual Funds

Equity and Equity-oriented Hybrid Funds

Short-term holdings (less than one year)	Long-term holdings (more than one year)
Taxed as short-term capital gains, currently 15 per cent	Not Taxed
All Other Funds
Short-term holdings (less than three years)	Long-term holdings (more than three years)
Taxed as per applicable marginal rate of tax	20% with indexation

Dividend Income from funds

Type of investment	Dividend tax
Equity and Equity-oriented Hybrid Funds	None
All Other Funds	25%*
* for individuals and HUF, plus surcharge as applicable and 3% education cess

Where and how to buy funds?
Like the many mutual fund schemes to choose from, there are several ways in which one can invest in them. One can invest online or offline or in direct as well as regular plans. Like everything else, each option has its limitations and advantages, which vary for each investor.


Direct Plan: Since January 1, 2013, all mutual fund houses have rolled out a new plan under all of their existing fund schemes-the Direct Plan. These plans are targeted at investors who do not make their mutual fund investments through distributors and hence have a lower expense ratio compared to existing fund schemes of the AMC.
This means that you, as an investor, will get an opportunity to earn a slightly higher return from your mutual fund despite it having the same portfolio. The direct plans will not charge distribution expenses or commission, resulting in these plans having lower annual charges and eventually, a different (higher) NAV compared to the regular plans.


Through intermediaries: There is a wide variety of intermediaries available. These include most banks, distribution companies having national or regional presence, some stock brokers (including online brokers) and a large number of individuals and small financial advisory companies. All intermediaries have to be registered with the Association of Mutual Fund in India (AMFI), which also maintains a searchable online directory at www.amfiindia.com. The website also lists intermediaries who have been suspended for malpractice to protect investors from going back to them.
The intermediary, normally brings the required mutual fund application form, helps you fill the forms, submit the forms and other documents to the Mutual Fund office and sometimes even brings in the Account Statement. But, all these services come to you for a fee. Typically, agents charge a flat fee for these services.


Through IFAs: IFAs are independent Financial Advisors, who are individuals who act as agents to facilitate a mutual fund investment. They help you fill the application form and also submit the same with the AMC.


Directly with the AMC: You can invest in a mutual fund scheme by investing directly through the AMC. The first time you invest in any Mutual Fund, you may have to go to the AMC's office to make your investment. Subsequently, future investments in different fund schemes of the same AMC can be made online (provided this facility is offered by the AMC) or offline, using the folio number in your name. Some AMCs may extend the facility of sending an agent to help you fill the application form, collect the cheque and send the acknowledgement.


Through Online Portals: There are several third party online portals, from where you can invest in various mutual fund schemes across AMCs. Most of the portals have tie-ups with banks to facilitate easy fund transfer at the time of investing. These portals charge an initial fee to setup an account and facilitate future smooth online access to invest and redeem your investments.


Through your bank: Banks are also intermediaries who distribute fund schemes of different AMCs. You can invest directly at your bank branch into fund schemes that you wish to invest in.


Through Demat and Online Trading Account: If you have a demat account, you can buy and sell mutual funds schemes through this account.


Electronic Money Transfer
The traditional way to transfer money from one bank account to another is to write a cheque and then deposit it. The advent of technology has ensured that one need not go through such a tedious process anymore. Over the years, the RBI has introduced several steps that has resulted in paperless transfer of funds through electronic funds transfer (EFT). There are several other acronyms that one comes across, especially when transferring funds online or through electronic clearances such as RTGS, NEFT, IMPS and ECS. Each of these plays an important role in ensuring your investments are timely and you do not lose time when investing. Each of these options plays a role in the way your investments are treated in a mutual fund.


Electronic Clearing Service (ECS): ECS is an electronic mode of payment or receipt for transactions that are repetitive and periodic in nature. For this reason, ECS is most preferred and useful when investing through SIP. Essentially, ECS facilitates bulk transfer of money from one bank account to many bank accounts or vice versa.
Primarily, there are two variants of ECS-ECS Credit and ECS Debit. ECS Credit is used by an institution for affording credit to a large number of beneficiaries having accounts with bank branches at various locations within the jurisdiction of a ECS Centre by raising a single debit to the bank account of the user institution. ECS Credit enables payment of amounts towards distribution of dividend, interest, salary, pension, etc., of the user institution.


ECS Debit is used by an institution for raising debits to a large number of accounts maintained with bank branches at various locations within the jurisdiction of an ECS Centre for single credit to the bank account of the user institution. ECS Debit is useful for payment of mutual fund SIPs, because these are periodic or repetitive in nature and payable to the user institution by large number of investors.


National Electronic Fund Transfer (NEFT): This is a nationwide payment system facilitating one-to-one funds transfer. Under this scheme, individuals, firms and corporate can electronically transfer funds from any bank branch to any individual, firm or corporate having an account with any other bank branch in the country participating in the Scheme. Individuals who do not have a bank account (walk-in customers) can also deposit cash (up to R50,000) at the NEFT-enabled branches with instructions to transfer funds using NEFT. At present, NEFT operates in hourly batches - there are eleven settlements from 9 AM to 7 PM on weekdays and five settlements from 9 AM to 1 PM on Saturdays.


Electronic Funds Transfer (EFT): This is a paperless method by which money is transferred from one bank account to other bank account without the cheque or currency notes. The transaction is done at bank ATM or using Credit Card or Debit card. In the RBI-EFT system you need to authorise the bank to transfer money from your bank account to other bank account that is called as beneficiary account. Funds transfers using this service can be made from any branch of a bank to any other branch of any bank, both inter-city and intra-city. RBI remains intermediary between the sender's bank called as remitting bank and the receiving bank and affects the transfer of funds. Using this method, funds are credited into the receiver's account either on the same day or within a maximum period of four days, depending upon the time at which the EFT instructions are given and the city in which the beneficiary account is located. Usually the transactions done in first half of the day will get first priority of transfer than the transaction done in second half.


Real Time Gross Settlement (RTGS): The real time gross settlement is an instantaneous funds-transfer system, wherein the money is transferred in real time. With this system you can transfer money to other bank account within two hours. In this system there is a limit that you have to transfer money only above R1 lakh and for money below R1 lakh transactions, banks are instructed to offer the NEFT facility to their customers. This is because; RTGS is mainly used for high value clearing. The RTGS facility is available only up to 3 PM and inter-bank transactions are possible up to 5 PM.


Interbank Mobile Payments Service (IMPS) Facility: IMPS is a platform provided by National Payments Corporation of India (NPCI). IMPS allows existing unit holders to use mobile technology/instruments as a channel for accessing their bank accounts and initiating inter bank fund transaction in a with convenience and in a secured manner. It allows to invest 24*7 via mobile phone.


How does it work?

• Unitholder needs to register for Mobile Banking with his Bank
• The bank issues a unique MMID (Mobile Money Identifier) which is a combination of his bank account and bank code and also issues an M-PIN, a secret password.
• Unitholder can now perform transaction using mobile banking application or SMS / USSD facility as provided by his Bank. For example: If unitholder wants to invest Rs. 10,000 in a mutual fund scheme using the mobile application, he needs to follow the following steps - In the mobile application; provide the
  • MMID of the scheme
  • His Mutual Fund Folio No.
• Amount to Invest/transfer
• MPIN issued by the bank remitting bank validates the details and debits the account of the Unitholder. It passes on the information to the beneficiary party (AMC in this case) via NPCI.
• AMC shall, after validating the details, credit the folio/scheme account with the appropriate units and shall also provide an SMS/email confirmation to the Unitholder informing of the allotment

Unitholder should ensure that the Mobile number registered with Bank for IMPS facility is the same as mobile number registered with Mutual Fund for the folio.


Electronic payments
IFSC or Indian Financial System Code is an alpha-numeric code that uniquely identifies a bank-branch participating in the NEFT system. This is an 11 digit code with the first 4 alpha characters representing the bank, and the last 6 characters representing the branch. The 5th character is 0 (zero). IFSC is used by the NEFT system to identify the originating or destination banks or branches and also to route the messages appropriately to the concerned banks or branches.

 

Happy Investing

Mutual Funds Vs Real Estate – Which is better for Investing in India?

Mutual Funds Vs Real Estate – Which is better for Investing in India?

Real Estate or Mutual Funds? This might be one of the most controversial debates I am starting on Stable Investor. But I had to write about it someday. And by the number of mails I receive from readers asking me to answer this question, it seems that there is much more than just financial logic behind this question. Peer pressure, family pressure and just getting done with this big decision in life are some, which I can think of right now.

But if you expect us to give you a clear answer at the end of this post, then please tone down your expectations. We do not intend to provide a thumb rule or even a judgment for that matter.

This question of whether you should invest in Real Estate (for investment) or Mutual Funds, can only be answered by you and you alone. This article should ideally be read in that spirit.

So lets go ahead…

In words of Ajay, a home is a place to live and it should not be linked to one’s investment strategy. There should not be any second thought given about buying your 1st property for self-occupancy whether with or without tax benefits.

My take on this question is not as strong as that of Ajay. But I do agree with him about the power of equities in the long run. As far as my real estate is concerned, I am still weighing my options and am yet to finalize my long-term real estate strategy. As of today, I don’t own any personal property but my family does have a house in our native city.

So why am I delaying this decision unlike many of my friends who are already paying hefty EMIs every month?

I know it might sound odd to those who believe that one should invest in property starting with the very first salary they get. But I am sorry… I don’t belong to that school of thought. I have full faith in power of compounding and investing in equities. And I will only buy my first piece of real estate when I am comfortable enough to service my EMIs. I don’t want to have myself stuck in years of paying EMIs where I feel burdened at the end of every month. I don’t want to be slave of my EMIs.
But that was about me and my philosophy….  So you can ignore it…

And for those who think that instead of paying rent, its better to pay EMIs – I have an answer. Paying rent might seem like an expense. But EMI also has a significant component of interest, which even in accounting term is nothing, but Expense. So this argument does not stand completely true.

Once again I repeat that the objective of this article is to highlight the differences in returns earned by investing in mutual funds and those earned by investing in a home funded through a loan, in the name of investment and tax-saving.

We have tried comparing two cases:

One where investment is made in real estate and other where it is made in mutual funds.

So here it is…

Case 1: Real Estate Investment

Following is the data being used:

Value of Property = Rs 75 Lacs (1500 sq ft @ Rs 5000/sq ft)
Required Initial Down Payment (@20% of Property value) = Rs 15 Lacs
Loan Availed (for remaining 80%) = Rs 60 Lacs
Loan Tenure = 20 Years
Loan Interest Rate = 10.15%


Few more administrative costs are as follows:
Loan Processing Charges & Other Expenses (@2% of Property) = Rs 1.5 Lacs
Registration Fees (@10%) = Rs 7.5 Lacs

 After doing some calculations which are depicted below, we arrived at quite interesting numbers.

Interest Paid over 20 Years = Rs 80.30 Lacs

And as you can see in the last column in table above, this property has also been able to generate post-tax and expense adjusted rental income. We used a few assumptions for rental income and expense which are as follows:

• Rentals increase by 5% every year
• Rental income from property is taxed at 20%
• Maintenance expenses are recurring every 5 years: Rs 1 Lac (5^th year), Rs 1.5 Lac (10^th year), Rs 2 Lacs (15^th year) and Rs 2 Lacs (20^thyear)
  All in all, these result in an amount of Rs 24.67 Lacs being generated from the property over a period of 20 years.
  This means, that effectively the property costs about Rs 1.39 Crores as depicted in table below:

Now as per general perception (at somewhat backed by data too), the properties are known to appreciate in price. But here, we are not talking about property prices doubling every 2-3 years. We are talking about much sensible returns ranging from 9% to 12%.

Lets see what this part of the calculation leads us to:

We will evaluate 3 scenarios where property appreciation is taken as 9%, 10% and 12% continuously for 20 years. And this evaluation is depicted in table below:

To summarize the above calculations, this property initially cost Rs 75 Lacs. But since loan was taken and it also generated rental income, the total landed cost was Rs 1.39 Crores.

Now when 3 different scenarios are considered where this property appreciates by 12%, 10% and 9%, the expected net gains are Rs 5.1 Cr, Rs 3.4 Cr and Rs 2.75 Cr respectively.

Agreed that these are some really big numbers.

But before you start putting your hands on your mouth after reading them, lets check out the second case where we evaluate similar investments in mutual funds.

Case 2: Mutual Fund Investment

We are using the following data for this case:

Initial lumpsum investment in MF schemes of Rs 24 Lacs. This amount is equal to the sum of Initial Property Down Payment (Rs 15 Lacs), Registration Charges (Rs 7.5 Lacs) and Loan Processing fees (Rs 1.5 Lacs).

Now the EMI amount in earlier case was Rs 58,459. This amount in this case can be used as monthly SIP. But we also need to consider the tax benefit of Rs 1 Lac availed on house loan investment – which is to be equated monthly. That amounts to Rs 8333 and resultant amount available for monthly SIP is Rs 50,126.

So here is the calculation sheet for two types of investment scenarios.

First one is where returns from MF move from initial 12% to 7% in later years. These are conservative numbers when compared to returns given by really good MFs.

Second one is a slightly aggressive returns assumption based analysis. Here the returns move from 15% initially to 7% in later years. But even then the returns of 15% are not that rare and have been achieved by quite a few funds in India for decades.

Now what happens when these funds are sold after 20 years? There wont be any tax as long term capital gains is not taxed in India for stock market returns.

So for an investment of Rs 1.44 Crores (lump sum + SIP of 20 years), a corpus of Rs 10.28 Crs and Rs 7.06 Crs has been achieved. And mind you, this return has been achieved despite having paid the additional tax @ 8333/- per month for 20 years. And these numbers are substantially higher than the real estate investment even after tax saving.

This means a net expected gain ranging from Rs 5.61 Crs to Rs 8.84 Crs.

Compare these numbers with those of Real Estate case and you will understand what this article is trying to point you towards.

Why do People Invest in Real Estate?

We have tried to list down a few reasons which we though people have for investing in real estate. And here were are not talking about the 1st House but about the 2nd property, which is treated as an investment:

1.    There is mental comfort in buying a hard asset that you can see and feel (also applicable to gold).

2.    It is an asset that can be funded largely through long-term debt (75% Funded by banks). No other asset provides such a benefit.

3.    It is a big asset, which you can acquire and then comfortably pay back via monthly payments (EMIs) over a very long period of time. Once again, no other asset provides this benefit.

4.    The comfort we get by doing mental accounting about tax savings in real estate investments. One always feels happier when one is told that they don’t need to pay tax or no money would be deducted from salary, because of tax savings due to loan-funded real estate investment.

5.    Second income from spouse, which can be used to get additional tax benefits (by being a 1^sthome loan for the spouse) by taking a home loan.

6.    Comfort of getting a stream of rental income. An income, which you get without working for – passive income. But most of the times, people forget about the linked expenses.

7.    General opinion that it is a hedge against inflation.

8.    Mental fix that there is Zero Risk in real estate purchases (in reality, there are more risk than most other investments like gold and mutual funds).

9.    Justification that it is an investment for the next generation(s).

10. High return expectations due to the recent past records (say last 15 Years).

11. Black money at work!!

12. Pride of owning multiple real estate investment and being known as the ‘Landlord’.

13. As there is no daily ticker, the daily mental valuation of the asset does not take place.

14. Mental satisfaction and happiness when disclosing to others that you own multiple properties.

15. The perception that since everyone is investing in real estate and profiting from it, even I should do the same and make easy money.

16. You always hear story from neighbors that they bought a flat for Rs 900 / sq ft 15 years ago and now it is worth Rs 5000 / sq ft. Here mental maths comes into picture. Mentally you might think that this 900 to 5000 appreciation is more than 5 times and a very profitable one. But neighbors comfortably forget to tell you about the expenses they incurred in these 15 years or in repaying loans. Actual returns are always calculated net of expenses. Its neighbor’s envy and owner’s pride (copied from an old Onida TV advertisement). For those who want to turn Rs 900 to Rs 5000 in 15 years, it’s not that tough. You can do it at 12.1% per year.

Why Don’t People Invest in Mutual Funds?

Since you are reading Stable Investor, chances are high that you would be a mutual fund investor. But there are many who avoid mutual funds to invest in real estate. Lets see what are the possible reasons for them to do so:

1.    Lack of knowledge about mutual funds and equity markets.

2.    Lack of understanding about the power of compounding, the power of equity as an asset class and clear knowledge of wealth building via SIP.

3.    Lack of knowledge about asset allocation.

4.    Risk and loss aversion.

5.    Unable to determine financial goals and estimate the amount required.

6.    They have already utilized all the tax benefits available to them because of home loan. Now they have no tax-incentive to invest in mutual funds. And hence they don’t do it!

7.    Bad past experiences. And these are primarily due to wrong fund selection or wrong time horizon or wrong advice (like combining insurance and investment or wrong thinking that saving and investing are same).

8.    As daily price movement of MF through NAVs is available, the daily mental valuation of the asset, forces one to take frequent buy and sell related decisions. This is driven by general lack of patience in investors.

9.    Mutual Funds cannot be funded through Black Money.

10. Unlike real estate, no long-term loans are available for investments in mutual funds.

11. More people talk about losses made by investing in funds (for whatever reasons) and very few people talk about their success in meeting financial goals through funds.

12. Mental fixation with recent huge loss events (like 2000, 2009, 2013 etc.)

13. A major chunk of saved money has already gone into real estate, which leaves almost no money to invest in mutual funds.

14. And as substantial money is not invested regularly in mutual funds, one does not feel that substantial money can be made through mutual funds.

15. You don’t get to hear every day that a fund having a NAV of Rs 28 has grown after 15 years to Rs 805 – a return of 25% per year (Check Reliance Growth Fund). Such returns are very high ones and rare and cannot be matched by real estate investment or investments in other asset classes.

Now lets test your memory…

Do you remember how much did petrol cost in the year 2000?

It was around Rs 25. As of today, it is about Rs 66. Now suppose you had invested that Rs 25 in real estate, which grew at 12.1% as mentioned few paragraphs earlier. This would have grown to Rs 139. Enough to buy 2 liters of petrol today. Now if this was invested in a mutual fund, which somehow could manage 25% return, it would have grown to Rs 711. Enough to buy at least 11 liters of petrol.

That is how equities work. That is how compounding works. That is how value of your money is preserved and increased by investing in right asset class for long periods of time.

Concluding Thoughts

And this is a repetition of earlier statement. One should not give any second thought about buying your 1st property for self-occupancy, whether it is with or without tax benefits.

However, based on our comparative analysis above (and estimated returns), one should think twice (or even ten times…) before buying a second home for investment purpose. One should carefully weigh all the available data and then take a wise call. Just because your friend or family member is investing in real estate does not mean that you should also do it. You should evaluate your own financial goals and think about how you plan to achieve it, and then decide whether you want to ‘invest’ in real estate or not.

A hard and physical asset will always give a huge mental comfort and satisfaction over other financial assets like mutual funds. But it is also true that it may not always be the best available investment option. In fact, investing in house funded through loan, is a huge long-term liability – which chokes the ability of the person to save and invest in other right instruments for future.

In our opinion (and it is ours and you can ignore it), after purchase of the 1^st property for self-use, if there is any surplus cash left to invest, you should invest it as per your asset allocation (which includes debt, equity, gold & real estate). If the asset allocation permits you to invest in real estate, you may very well do it. But if it doesn’t, then you should refrain from investing in it. Investing in real estate for the sake of saving tax may not be the best thing to do.

As stated at the beginning of this article, this is one hell of a controversial debate. And there is not straight-forward logical answer to it. There are no thumb rules or any other rules. The question of Real Estate Vs Mutual Funds can only be answered by you an you alone.

We have simply made an attempt to clear the myth that “Real estate investing is the only best Investment Option” available for everyone. We have done all the calculations by estimating the returns net off expenses. We cannot just ignore expenses like those who just tell you the number of times their property has appreciated in value.

Happy Investing

Source: SmartInvestor.com, Moneycontrol.com