Which is the wiser of the two investments — starting an SIP of Rs 20,000 for 20 years in a mutual fund or taking a home loan for a second flat with an EMI of Rs 20,000 for 20 years?
— Thomas
If you look purely at quantitative parameters, the second flat is likely to give better returns than the equity fund.
We arrive at this conclusion based on a few assumptions. To start with, let us suppose that both the equity mutual fund (in which SIP of Rs 20,000 per month is made for 20 years) and the second flat (which is repaid through EMIs of Rs 20,000 for 20 years) appreciate at 12 per cent annually. The interest on the home loan is charged at 10 per cent annually and the entire value of the flat which works out to around Rs 20.7 lakh is financed through the loan. Rental yield on the flat after tax and expenses is 1.5 per cent. Both the flat and the mutual fund are sold after 20 years.
In this example, after 20 years, we arrive at after-tax gains of around Rs 1.7 crore on the flat, while the mutual fund nets you around Rs 1.5 crore. This is because the real estate investment enjoys a few unique benefits – high leverage (the whole flat value starts appreciating from the beginning even as your loan repayment is staggered), tax benefits on repayment of interest and principal, and rental income. A higher rate of return on the property than the cost of the loan also helped.
But before taking the plunge, do take note of qualitative factors on which mutual funds seem to have the upper hand.
The top equity mutual funds have delivered returns of over 20 per cent annualised in the last 10 years. Returns on an equity mutual fund held for more than one year are also tax-free. This improves its post-tax returns.
Plus, with equity funds you can diversify your risk across 3-4 good funds each holding a minimum of 20-30 stocks. This reduces the chances of your losing money. Selling a mutual fund is easy - this earns it brownie points on liquidity. But returns and risk go lock-step. Any investment in equity carries the risk of capital erosion, but this risk is more worrisome in the short term.
And contrary to popular perception that real estate prices only head north, property rates also go through cycles when they can stagnate or even decline. Case in point are markets such as Hyderabad, Jaipur and Kochi where real estate prices today are lower than in 2007 (Source: NHB Residex). So, ‘assured high returns’ in real estate is a fallacy. Risk is very much there, especially with the steep rise in property prices over the past few years which has impacted affordability.
A big risk with investing in property that it is difficult to diversify or liquidate. Usually, you will end up investing the entire sum in one property in a single location. Selling a property can be quite time-consuming. Besides, you need to do your homework thoroughly (check title deeds, sale agreements, approvals) when buying property so as to not get caught in a tight spot.
Therefore, on parameters such as concentration risk and liquidity, an investment in equity mutual funds scores over property.
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