Mutual funds or Real estate, which is better?

Mutual funds or Real estate, which is better?

Diversified equity funds tend to give higher returns compared to real estate.

If you are a salaried employee, do not invest in property.

Many of us are very comfortable with real estate as an asset class. Real estate is tangible and we feel we have full control on it. Most of us believe it to be less risky and think the return is highest and unmatched by any other asset class.

Thousands have personally seen their real estate investments grow manifold.  A Rs 15 lacs property bought in a metro in 2000 is probably priced at Rs 75 lacs today.

There is always demand for real estate and historically the prices have been going up sharply. There is hardly been any instance of prices of properties dropping drastically. This makes real estate the most obvious investment option. The only reason one may not have made investments in real estate is lack of funds.

On the other side people have different perceptions about mutual funds. They believe that mutual funds are very risky. Investing in mutual funds or stocks is akin to gambling. Returns generated in mutual funds are less than in real estate.

What is the fact? Is real estate actually the best or a mutual fund is a better option?

We will broadly look at two parameters to establish the truth; Returns and risk.

Returns in real estate:

Let us take the earlier mentioned example. Property bought in 2000 at Rs 15 lacs is worth Rs 75 lacs today. Growth of Rs 60 lacs in a matter of just 12 years.

Let us mathematically check at what rate it has grown. We know that bank deposits give - 9% per annum. How do you find how much has the property given every year?  We can use the compound annual growth rate (CAGR) or use XIRR function in MS excel.

The property grew at the rate of 13.17% for the period Jan 2000 to Jan 2013.
Now, assume one had invested Rs 15 lacs in HDFC Top 200 G for the same period. He would have made Rs 1.29 crs at a rate of 18%.

Large cap diversified equity funds tend to give higher returns compared to real estate in the long term. 

Now let us look at the risks..

Only the ignorant will claim real estate is less risky than mutual funds. It is a matter of perception. The matter of the fact is that both equity mutual funds and real estate both belong to the growth asset category.  The performance of both real estate and equity mutual funds as an asset category majorly depends on the performance of overall economy. If the GDP grows at 8% you can expect real estate to grow at 13-14% and equity mutual funds to grow at 15-17% in the long run. The term is LONG RUN.

How do we plan investments?

Do not see both real estate and equity mutual funds as mutually exclusive, meaning either real estate or equity mutual funds. If you are rich and have large surpluses then have both in your portfolio.

If you are a salaried employee, you may not have huge surplus to invest in property. Then do not take a home loan and invest in property. The best alternative will be to do an SIP in equity mutual funds; you will end up better off. In case you want a home to live and you are under family pressure, then you can take a home loan.