Indian Household asset allocation
According to RBI estimate, Indian household asset allocation is more or less evenly spread between financial assets and physical assets. Equity constitutes approximately 3%, whereas real estate (including land) has the lion’s share. While this may be true at pan India level given the preference for physical assets in under banked rural areas, the balance is tilted more in favor of financial assets in urban areas where the share of equity is also higher.
Returns
Return is the primary consideration for any investment decision. From this point, it has been observed that over the long term equities tend to give the highest returns. On the other hand, gold tends to outperform other asset classes during turbulent times or when the economy is slowing down. Real Estate gives higher returns over the long term and more steady returns than equity during turbulent times. This is validated by the data given in the table below:
As can be seen from above, during the last 5 years (post Lehman crisis), which have been the most difficult years for the global economy, Equities (Nifty) has given return of just under 4% whereas gold has given very high return of nearly 20%. Real estate on the other hand has given moderate to high returns depending upon the city (except Tech hubs like Hyderabad and Bangalore which were affected severely due to global slowdown).
Also it is pertinent to note that in case of investment in under construction property, the returns get enhanced due to the leveraging effect. This is because while the price is locked in at the time of initial payment (which could be as low as 5%) the full payment is to be made over a period of time, based on construction milestones.
Safety of capital
Another important consideration while making an investment is the safety of the capital. The general perception is that equities tend to be more risky due to volatility in price and that the capital can get easily eroded during market down turn or due to market manipulation. The ability to quickly sell equity in a panic situation, further accentuates this. The fact that equity investment is not backed by any tangible asset, adds further to the perception of risk associated with the equity.
On the other end people feel more secured while investing in physical assets like gold and real estate as one can not only own them but actually possess and enjoy them.
Liquidity
On this front Equity and Gold tend to score very high as one can conveniently sell them and realize the cash almost immediately. Real Estate, on the other hand, is not as easy to liquidate and it could take anywhere from one month to three months (or even more in adverse market conditions) to complete the transaction and realize the cash.
Taxation
Equities provide the most tax efficient return as not only dividends but also long term capital gains (holding more than I year) are completely exempt from tax. Further, short term capital gains are also taxed at concessional rate of 15%. Gold and Real Estate on the other hand do not enjoy such tax concessions. The long term capital gains (holding more than 3 years) are taxed @ 20% whereas short term capital gains are taxed at normal slab rate which go up to 30%. However, in case of Real Estate, tax benefits are available under section 54 of the IT Act, whereby, subject to certain conditions, long term capital gains on sale of property will be exempt from tax if the amount is used to purchase another property. Also a flat deduction of 30% is allowed from rental income. Further, in case of home loan, the principal repayment is allowed as deduction under section 80 C up to Rs. 100,000 p.a. (in aggregate with other investment like Life Insurance Premium, PF contribution etc.). Also interest is deductible up to Rs.150,000 p.a. in case of self occupied property and to the full extent in case of let out property.
Transaction Cost & Holding Cost
These are lowest in case of equity where brokerage is highly very low (0.20% to 1.00%) and demat holding charges almost negligible. In case of gold, this tends to be slightly higher on account of dealer margins at the time of buying as well as selling, more so in case of jewelry. The transaction cost is highest in case of real estate as one not only has to pay brokerage (1%to 2%) but also transfer charges to builder or society, stamp duty, registration etc. Also the holding cost is very high as one has to pay property tax, maintenance charges etc. This can be set off against rent if the property is let out.
Loan
Loan against equity is not very popular amongst retail and HNI investors in our country. It is neither marketed aggressively nor encouraged by the lenders (except for a few private banks). Also the margin at around 50% and cost at around 13% to 15% tend be very high. On the other hand loan against gold is gaining popularity of late thanks to the aggressive marketing by private lenders as well as banks. Money is available almost instantly and margin is also very low at around 30%. However, the rate of interest is very high ranging from 14% to 20%.
In case of real estate, especially for purchase of residential property, taking loan has now become a norm thanks to the easy availability, competition among lenders and tax concessions. Also one can borrow up to 80% of the value of the property. The interest is also the lowest at around 10% to 11%.
Comparative analysis
From above, one can conclude that equity investment can provide high return over long term. However, one must, have the stomach to digest the volatility associated with equity in the short to medium term. Investment in gold has traditionally been done to protect the capital and provide support during troubled times. Even today, it plays an important role in ones investment portfolio as a hedge or insurance against market meltdown or troubled economy. Real estate on the other hand is seen as an asset class which can provide high and steady return over a period of time and also alternate source of regular income by way of rent.