Whether one should invest in real estate or mutual funds is a question that haunts many minds. However, it’s impossible to answer this question truthfully without knowing the exact circumstances you are in. For the sake of understanding let’s assume that you are buying a house for investment and not for consumption purposes.
Having assumed that, the cornerstone factors that you want to consider before making any investment decision is return expectation (post-tax), volatility, risk capacity, time horizon and liquidity. Use these five factors to make quick initial decisions on what investment to choose. All things equal, you want to invest in a product that gives you the highest return while taking the least amount of risk and one which is highly liquid (easy to sell).
Let’s take the house v/s mutual funds question through these factors to identify the better option.
Post-Tax Return Expectation:
The biggest factor that governs any investment decision boils down to the returns one is expecting from the investments. Always take into account taxation on the investment as ultimately your post-tax return is what matters. Ensure that the expected returns are always compared to the amount of risk taken while investing in the particular instrument.
In this regard, equity mutual funds provide a more compelling alternative to real estate in our view if we just talk about post-tax returns. Both historical data and forward-looking metrics would support that.
Volatility is the risk you would undertake while holding on to a particular investment. Equity, as it is widely traded can be considered to be more of a volatile investment than real estate where price discovery is somewhat less frequent and volume is lower.
The volatility of an investment should also be cross-checked by the amount of risk you can personally bear when you are investing. Even if a particular investment has favorable risk-reward equations but if your personal risk capacity is not high enough to support risk, then you should not go ahead with it. Your risk capacity depends on a variety of factors like age, the number of dependents, your investment as a percentage of your total capital, the financial goal that you are investing for etc.
Time Horizon, after return expectation is one of the biggest factors to consider while making an investment. Generally, for high-risk investments, almost always you would be better off having a longer time horizon. Think about it this way, if you needed the money after a year would you ever invest in a house?
Mutual funds score over real estate when it comes to time horizon. This is because real estate sometimes requires a longer passage of time to unlock investment value.
The last thing to consider is liquidity. Liquidity, in layman’s terms, means the ability to redeem your investment whenever you need to. It is a function of the availability of a buyer for your investment and the absence of any lock-in’s.
Mutual funds score big over real estate when it comes to liquidity. The liquidity in real estate is frequently low. As opposed to that the mutual fund units are redeemable whenever needed in the absence of a lock-in period.
The above factors suggest that equity mutual funds are a better alternative to real estate as a future investment. However, it would be foolish to make an assumption without knowing the actual circumstances of the person trying to invest. In both cases, the kind of mutual fund or real estate that you choose affects your investment returns.
If you decide to invest in mutual funds, do check out Moneyjar where we help you choose and invest in mutual funds that are customized for your exact needs and circumstances.