Which Is a Better Investment?

Moreover, the tax benefit on home loans available (under Section 80C for deduction of the principal amount of the home loan, plus interest under Section 24(b) of the Income Tax Act 1961) proved to be sweeteners, resulting in a lot of demand for real estate, appreciation in property prices, and many even began considering as a promising asset class to invest in.

But the question is whether real estate is still the best asset class to invest in even today, particularly when there are many other lucrative or productive avenues available.

Reserve Bank of India’s (RBI) All-India Housing Price Index, which is released quarterly and measures the change in residential housing across 50 cities in India and is slated to capture data from over 100 cities, including all state capitals and ‘smart cities’, reveals a slower year-on-year (y-o-y) growth or increase in property prices compared to more than decade ago (see the red line in the graph below).

Particularly after the financial year 2016-17, the y-o-y appreciation in property prices has been subdued.

In Q4FY 2023-24, all-India HPI increased by just 4.1% y-o-y in Q4:2023-24 compared to 4.6% a year ago. In other words, real estate earned returns akin to interest earned from a savings bank account.

Moreover, the annual HPI growth has varied widely across widely across the cities — ranging from a high of 11.7% (for Ahmedabad) to a low of -0.3% (for Jaipur).

So, what this shows is that the returns you yield could vary significantly depending on which region or area your real estate property is located, and in certain years it may not be good enough to catch up with headline inflation. The returns may be far slower than other asset classes. Nevertheless, real estate holds an emotional value for investors.

After the COVID-19 pandemic, while people have aspired to own bigger homes, the returns from real estate (going by the graph above) are nothing to vie for. In some cases, the cost of maintaining the property has exceeded the returns.

For those who have chosen to let out their residential property for a license fee, the rental yields earned (calculated as annual license fee or rent divided by the market price of the property) is barely around 3-4% — despite the improvement from the pre-pandemic levels.

Yet most often individuals often foolishly evaluate the license fee or rental income considering the ‘absolute sum’ received instead of how much is the real ‘yield’. Also, when evaluating returns often the prices are compared against the year it was purchased with scant importance to the number of years the asset was held to weigh the compounded annualised returns clocked.

Also, what needs to be kept in mind is the liquidity aspect. Real estate as an asset class is less liquid compared to other productive asset classes such as equity, gold and debt.

Say you wish to sell a property invested in years ago, the liquidation process could be long-drawn, tiring, and complex. You may realise a lesser sum than the true value of your property. In other words, there is no natural and consistent price discovery. It all depends on where the property is situated, how well it is maintained and so on.

And finally, when you sell the property, there are capital gain tax implications. In the recent union budget 2024-25, the Modi 3.0 government made changes to the capital gain tax on property. The Finance Bill 2024 allows you the taxpayer to select either 12.5% Long Term Capital Gain Tax (LTCG) on the property without indexation benefit OR pay 20% LTCG tax by availing of the indexation benefit for all real properties acquired before July 23, 2024 (i.e. the date from which the union budget 2024-25 has come into force), instead of the earlier cut of April 2001.

However, for the property(s) acquired/ purchased/constructed after July 23, 2024, there is no indexation benefit available to you, the taxpayer; there is no choice but to pay a flat 12.5% LTCG tax, just as any other financial asset. This, in my view, is a bit of a dampener.

[Read: Capital Gain Tax on Property After Modi 3.0’s Budget 2024-25. Here’s All You Need to Know]

Also, now the New Tax Regime — which is the default tax regime — offers no tax benefit on buying/constructing the property. The only deduction available under standard deduction against income from salary, deduction under family pension, and for employer’s contributions made to pension scheme.

To avail of the deduction for principal repayment of the home loan and the interest thereon, you, the taxpayer, need to opt for the Old Tax Regime, wherein the basic exemption limit on the gross total income is less than the New Tax Regime and tax rates haven’t been rationalised. In coming years, it is also possible that the government will do away with the Old Tax Regime.

[Read: Is the Revised New Tax Regime Truly Beneficial for You? Find Out Here…]

While real estate may be a favoured asset class, doing your homework is necessary because, as you know, it is a high-value investment. There is not much scope for diversification. So, you need to be mindful of the market trends, regions offering lucrative returns, and the tax implications, plus be cognisant of your risk profile. Keep in mind, that real estate is not a risk-free investment.

Mutual Funds

In contrast, mutual funds, depending on your risk profile, investment objective, and time horizon, offer a variety such as equity mutual funds, debt mutual funds, hybrid funds solution-oriented funds, commodity funds (gold and silver) etc. to choose from. You benefit from diversification, the expertise of a professional fund manager, enjoy economies of large scale, and can invest by making staggered lump sum and/or systematic daily, weekly, monthly, quarterly or bi-annual SIPs.

In fact, recognising many of the benefits and returns clocked, in recent years, mutual funds have become a popular choice of investment among retail and High Net worth Individuals (HNIs).

SIPs, a mode of investing in mutual funds, have become a household name. SIP contributions have touched a record high of Rs 23,332 crore and the Asset Under Management (AUM) of the industry stands a little over Rs 64 lakh crore (compared to around Rs 10 lakh crore a decade ago). Out of the total AUM, the SIP AUM today stands over Rs 13 lakh crore.

The total number of mutual fund folios or accounts as of July 31, 2024, stood at 19.84 crore, out of which 9.34 crore are SIP folios.

Today individual investors (which include retail and HNIs) hold a higher share (61%) of industry assets, and therein a dominant share of the assets is held in equity-oriented mutual fund schemes, followed by certain debt-oriented mutual fund schemes. Interestingly even the B30 locations are taking the risk and deploying money into mutual funds.

The returns clocked by mutual funds, by and large, have been noticeably better than real estate and other traditional investment avenues.

As seen above, the category average return of equity mutual funds (wherein all sub-categories of equity schemes are considered, including index funds and Exchange Traded Funds are taken into consideration) have been quite appealing, earning decent compounding annualised returns over longer time periods. Note, in the case of equity investment a CAGR of over 12 or 15% is considered very respectable.

Similarly, the Hybrid Equity-oriented mutual funds have clocked appealing CAGR. Even the Debt-oriented Hybrid funds and Multi-Asset Allocation Funds (which tactically invest in equity, debt, and gold) have compounded money at a decent pace.

In the case of debt mutual funds as well, depending on the time period you are looking at and accordingly the sub-category, the average returns by and large have been in good order.

Likewise, against the backdrop of geopolitical tensions, geoeconomic fragmentations, supply chain disruptions, inflation risk, and burgeoning debt-to-GDP ratio in many economies, gold mutual funds have done with the underlying asset gold exhibiting sheen.

[Read: Have Sovereign Gold Bonds Lost Sheen After Modi 3.0’s Full Budget 2024-25]

Like investment in real estate, there is a market-linked risk in the case of mutual funds as well. But if you prudently select mutual funds based on the returns across time frames, across market phases (bear and bull), evaluate if the scheme has managed to justify the risk by the way of risk-adjusted returns (as denoted by the Sharp ratio), assess the portfolio characteristics, and check if robust investment processes and systems are followed at the fund house level, you would be able to add some of the best mutual funds to your portfolio. Watch this video to know the factors to choose the best mutual funds:

As regards liquidity is concerned, it is important to note that mutual funds are highly liquid than real estate. Depending on the time of scheme equity, debt, or gold, the money can be redeemed within 1 day in case of liquid and up to 3 to 4 working days in case of other mutual fund schemes.

Note, the high liquidity and return potential of mutual fund schemes, make it possible to align investments with your important financial goals — be it keeping money safe for an emergency or short-term needs into a liquid fund, to planning for fairly long-term goals such as planning for your child’s future (higher education and wedding expenses) and your retirement with equity and various other mutual fund schemes.

In conclusion…

While some readers may find the comparison between real estate and mutual funds bizarre, like comparing apples with oranges, do note that the ultimate objective of any investment is to yield respectable returns and create wealth.

If you are considering residential property for self-use i.e., as a primary home, any time is a good time to make that decision with your own funds or borrowed funds (availing a home loan). In such a case, it would carry more of an emotional value than an investment value, where returns are secondary.

But when it comes to making an investment, making rational decisions, based on the returns, risk, cost of capital, liquidity, flexibility (allowing you to decide entry and exit as per changing market conditions), and the tax implications are paramount. Don’t allow emotions to take over.

Invest your hard-earned money sensibly in wealth-creating avenues.

Be a thoughtful investor.

Happy Investing!

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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.