I just came across this article online and I thought to myself that this should be the first topic of our blog section as it is something which should entice and be an eye- opener for our readers.
So, just to give you a brief background about the person in this picture, He is Mr. Rakesh Jhunjhunwala and is a self made billionare investor and trader. He is also a chartered accountant by qualification. As per Forbes, he is the 54th richest person in India, with net worth of USD 3 billion (as of 1 June 2018).
So, there has been a lot of buzz on the street which I have noticed about real estate being far more superior to any other asset class in terms of wealth creation & I wouldn’t disagree but at the same time one also has to see the returns generated by equity in the past 30 years and when I say equity I mean to say Sensex/ Nifty to arrive at a conclusion.
To begin with, let us first understand the formula of wealth creation:
Wealth Created = Initial Investment X (1+ Rate of Return) ^ No of Years
So, there are 3 components namely:
- Initial Investment
- Rate of Return
- No of Years
- The initial investment in the case of real estate is really high and this is due to its lack of divisibility (you can’t buy in bits & pieces) but whereas in the case of equities, you can hold even 1 share of a company!! So Real estate in this point wins over Equities/Stocks.
Word of Caution: Higher investment leads to higher corpus value. However, if one uses SIP effectively in purchasing stocks/Equity Mutual funds then investment amount over number of years can be significant but for that one has to be patient and disciplined.
- Number of years you hold to an asset is correlated with its property of tangibility. Anything which is tangible is easier for us to hold for a really long period of time and stocks is something which is intangible and as a result of which people are reluctant to hold. Also, tangibility gives the investor a sense of ownership.
So even in the case of a number of years, real estate wins over stocks.
Why the number of years matters in investing and how important is it?
Here is the list of eminent fund managers/stock pickers/investors that have created an enormous amount of wealth during their investment journey.
Observation: If you look at the above list, I have highlighted Warren Buffett’s name in green and the point I am trying to make here is that there were and are people who have generated returns more than Warren Buffett’s return (23%) but what really made Warren Buffett the richest man was that he generated 23% returns for 54 years !!! . This is the magic of compounding which Warren Buffett and investment fraternity often talks about.
- Rate of Return: This is something in which stocks wins over real estate. Compound Annual Growth Rate of Sensex is 15% for the past 30 years excl. dividend.
Since real estate return could not be generalised (as there is no formal market for it) but if you wish to buy a Real Estate and give it out for rent then you may just want to use this formula before purchasing one.
Rent Yield = Expected Annual Rent / Initial Investment or Cost X 100
If it is greater than 5%, then it’s a deal worth giving it a thought to buy!
It is one of the parameters to be looked upon while buying a property. It only measures the under/overvaluation of an asset. There is “n” number of factors to be considered while buying a real estate.
Example of how wealth has been created by investing in stock markets:
Value of Sensex (April, 1979) = 100 pts
Value of Sensex (April, 2019) = 38,800 pts
CAGR of Sensex (40 years) —– 16.05% (Using XIRR Function in Excel)
The above return is excl. dividends. It is safe to assume dividend yield of Sensex to be in the range of 1- 1.5%. Let us consider 1%
So Total Return = CAGR of Sensex + Dividend Yield = 17.05%
The journey of Sensex looks smooth in this picture however it is really volatile in the short term and because of its volatility, people miss out on creating horrendous amount of wealth for themselves.
Despite of several major events taken place as shown in the picture Sensex has always managed to create all-time highs in the past and will surely continue to do so in the future as the prospect of our country “INDIA” is really bright.
How people lose wealth in the markets?
Have a look at this picture below……
Returns in the stock market are always going to be asymmetric in nature and Investor always has to be prepared for the worse.
Always remember timing in the market is not important, time in the market is important.
As you see in the graph, there will be times in which investor would literally get zero returns for a really long period of time. But this uncertainty creates maximum amount of wealth if one is patient and disciplined throughout its investment journey.
Pros & Cons of Real Estate & Stocks:
- Liquidity: Stocks are very much liquid than real estate. Within a fraction of seconds, one can buy and sell stocks but that is not the case with real estate. Real estate lacks liquidity.
- Tangibility: It is often believed that tangibility leads to emotional stability and we can hold to a tangible thing for a long time as opposed to something which is intangible. So, Real estate wins over stocks when it comes to holding for a long period of time.
- Maintenance Cost: While buying a real estate, an investor may have to make certain periodic payments to keep its property maintained whereas stocks also carry maintenance cost but are negligible when compared with real estate.
- Hedge against inflation: Real Estate is an attractive investment if the goal is to hedge against inflation whereas stocks are volatile in nature and as a result of which they aren’t good instruments to hedge inflation.
- Valuation: Valuation in real estate is relatively easier than stocks. While buying a property, one can cross-check the prices of another property few blocks away and get to know if the property is under/over-valued but whereas in the case of stocks, valuation becomes really subjective.
- Diversification: Diversifying stocks and making a portfolio out of it is easier than buying several real estates and trying to create a land /plot bank as the entire process is a cumbersome and time-consuming job as opposed to stocks.
Equities are far more superior to Real Estate or any other asset class for that matter only if the investor is willing to withstand the volatility of the market in the short term & purchases quality companies at a decent valuation with a large investable amount for a long period of time (more than 15 years).
Logically, equities means buying parts of businesses which will keep generating profits year after year and higher the profits, higher would be the valuation of companies and thus this is how an investor creates wealth in the stock markets against buying a piece of land/apartment and giving it out for rent or buy and hold for an investment purpose and selling it in anticipation of rise in prices ( no logical argument as to why prices of real estate would rise except the fact that demand > supply in future).
Final Thoughts on Investing…………