You think investing in gold real estate will make you rich. You can’t be more wrong
Myth 1: Gold will help me protect my fortune
As mentioned earlier, an RBI report found that alongside real estate, gold, at 11%, accounts for the largest share of Indian household wealth. An 11 percent allocation to any asset is a reasonably large share by any standards. How has such material allowance worked for Indian households? Over the past ten / twenty / thirty years, the price of gold (in rupees) has compounded at an annualized return of 9.2% / 12.7% / 9.3%, respectively.
During the same periods, an investment in the stock markets, represented by an investment in the BSE Sensex index, was respectively 10.4% / 15.0% / 14.8% higher than gold during each period. If we look separately at the returns of gold in each of the three decades over the past thirty years, we see that gold has significantly underperformed the Sensex. During the decade 1990-2000, gold prices rose at an annualized return of just 2.8%, without even beating inflation. The narrowest margin by which gold has underperformed was in the decade 2010-2020, when gold prices rose 9.2% per year, compared to the Sensex’s 10.4%. However, during this decade, gold prices were more volatile (measured by standard deviation) than stocks, suggesting that on a volatility-adjusted basis, there was no compelling reason. to own gold.
Even though gold doesn’t offer higher returns than stocks, it could improve your portfolio’s risk-adjusted returns if it is negatively correlated to stocks (allowing you to diversify your returns). The general public perception is that gold is negatively correlated with stocks. However, the data on this is actually mixed. While gold has been negatively correlated to the Sensex over the past ten years, over longer time periods, namely twenty and thirty years, the negative correlation decreases and actually becomes a slight positive correlation. This means that over the last twenty and thirty years the prices of gold and BSE Sensex have moved more or less in parallel. Moreover, if we break the last thirty years down into three decades, we see that gold has, for the most part, been positively correlated with stocks. This means that using gold as a wealth diversifier also doesn’t work consistently. Overall, it is difficult to argue that gold is a significant part of an Indian investor’s portfolio.
The aforementioned RBI report also corroborates these findings and argues for a reallocation of wealth from gold to other financial assets. Reports indicate:
For households that hold larger amounts of gold, i.e. those in the upper third of the cross-sectional distribution, the continuous annual income gain resulting from the reallocation of a quarter of their holdings in gold to financial assets is 3.4%, which when capitalized translates into an upward movement of around 5pp along the distribution of Indian wealth. These projected gains are almost always greater than zero, even when taking into account the volatility that can lead to different realizations of returns on gold and financial assets.
Myth 2: Real estate will help me grow my fortune
Over the past five years, if one looked at the rate of return on real estate in India’s metropolitan cities such as Mumbai, Delhi and Bengaluru, one would see that yields have been around 3-4% per year ; that is, house prices have kept pace with consumer inflation at best. Real estate in large markets like the National Capital Region has not even accomplished that.
However, there is a school of thought in India that says that because residential property yields have been low over the past five years, they will be better in the future. This view cannot be supported when comparing Indian house prices with prices in other markets. The first problem is affordability. Indian residential housing prices, expressed as a share of GDP, are 6 to 10 times higher than prices in some comparable Asian economies.
Second, Indian residential rental yields are around 2-3 percent in most Indian cities, while the cost of a home loan for prime residential real estate customers is around 7 percent. The disparity between these numbers suggests that Indian residential real estate still has room to correct its highs before it becomes an attractive asset class.
Third, comparing Indian residential rental yields with yields in other countries suggests that the Indian residential real estate market is significantly overvalued. Other markets with rental yields comparable to India, such as Singapore and the United States, have borrowing costs in the range of 2-3%. In contrast, as mentioned above, in India the cost of a home loan, even for a preferred client, is much higher, around 7%. Indeed, the cost of a mortgage in India is much higher than in Indonesia (7% against 5%), even if the rental yields in Indonesia are much higher than in India. Obviously, investing in real estate in India does not make much economic sense. Add to that other factors, such as high transaction costs (brokerage, stamp duty, etc.), illiquidity (your property is useless enough to fund emergency cash calls) and lack of transparency. to find true value or price – and investing in real estate becomes cumbersome and risky.
This excerpt from Diamonds in the Dust: Consistent Compounding for Extraordinary Wealth Creation by Saurabh Mukherjea, Rakshit Ranjan and Salil Desai was published with permission from Penguin Random House.
Read all the latest news, breaking news and coronavirus news here