When it comes to investments, each individual has a different point of view with respect to expectation of returns as well as the amount of risk they are ready to take. Fundamentally, the decision on investment in any asset class should be based on the combination of factors like present financial situation, financial goals and risk appetite of the individual.
That being said, some common asset classes that you often hear are Real Estate, Equity and Debt. What should you choose? What are the pros and cons of each of these? How do these assets behave over short and long terms? To be sure, each asset category has its own risk and return features. So, let us get in to the details one by one.
First of all, the reason we are talking about Real Estate right in the beginning is because it is among the most popular assets in our social setting. You would often come across friends and family members who have made ‘investments’ in real estate. This even extends to multiple residential properties. Even among those who do not own a residential property at present, owning own has immense sentimental value attached with it.
As an asset class, the performance of real estate varies from place to place. Real estate prices in different Indian cities behave very differently. However, according to Anarock Property Consultants, the residential real estate prices appreciated by just 12% between 2013 and 2018 in India, meaning a mere 2% appreciation on average each year. At the same time, even rental yields from real estate in India hover around 2-3% only, says a report by property consultant Knight Frank and law firm Khaitan & Co.
One must also note that real estate prices and hence effective yields, are significantly impacted by economic cycles as well as by laws governing land ownership, tenancy, real estate, liquidity, etc.
Every time the Indian stock markets see a bull run, the interest in equity among retail investors spikes. After all, everyone wants to be a part of the India growth story and benefit from it. In a nutshell, this asset class should be explored from a long term investment perspective only. The reason for saying so is that in the short term, equity markets tend to be volatile, but in the long run, the volatility is covered up by stead growth.
Look at the numbers to understand the short-term and long-term performance of equity investments as well as to understand how this could vary from time to time. In the past 24 years, Nifty 50 has seen 17 years of positive growth and 7 years of negative growth. As of mid February 2020, the one month return from Nifty 50 was about (-) 2%, but the one year, five year and 10 year return stood at 12.7%, 37.6% and 151%, respectively.
Accordingly, the biggest positive about equity investments is that over a long term, it performs well. At least the historical data says so. Conversely, the biggest concern for equity investors is short term volatility.
For most retail investors, debt investments do not generate the level of excitement that real estate or equity does. This is because debt investments do not throw up flashy numbers like ‘multi-baggers’ do. Instead, debt investments provide a lower, but stable, return to the investors. The common debt investment instruments we often come across are fixed deposits, post office schemes or the employee provident fund. There are also bonds and debt mutual funds in the market.
As the returns are lower in debt investments, so are the risks. However, beware of a common myth that debt investments are free from risks. Depending upon the investment instrument, the risk could vary significantly. For instance, investments in government schemes like Public Provident Fund could be considered least risky due to the sovereign guarantee. At the same time, bonds issued by private entities could turn out to be high risk investments depending upon the financial health of the entity.
So where should you invest?
As explained above, each asset category comes with its own pros and cons. One asset might be suitable for you but might not be suitable for someone else you know. Ideally, you should not go overboard with any asset class, and have an optimum mix across all of them. This is also known as asset allocation. This also means that you should fight the temptation to invest all of your wealth in a single asset class, be it real estate, equity or debt.
However, situations might emerge when you could need to direct a large chunk of your wealth to a single asset class. For instance, if you are chasing only long-term financial goals, you might need to invest more in equity and very little in debt. Similarly, if you have no specific long term goal but only need to protect your capital while earning some stable returns, you would need to invest most of your money in debt assets.