Analysis of Stock Market vs Real Estate Investing

Have you ever wondered, how does investing in stock market compares with real estate investment? Well they both have their merits and demerits and are suitable for different sections of people.

While stock market is accessible to mass retail investors and is far more liquid, real estate investment requires more upfront commitment and may not be liquidated that easily.

Stock investing and real estate investing have the same basic financial objectives. People invest money in both to make money from growth and/or income. Growth through price appreciation (increase in value or market price) is where you really make the big bucks.

Here we have tried to compare these investment options from a very objective perspective and have considered both these avenues from pure investment vehicles.

For simplicity, we have assumed that both stock and real estate investment grow at same rate of 10 percent per annum. Further, same amount of investment at same periodicity is considered in both the options. The time horizon for investments to mature is taken to be 5 years.

Suppose you decide to buy a real estate house valued at 50 lacs by taking maximum i.e. 85 percent financing. This means you put 7.50 lacs as down payment and rest spread out as equated monthly installments at 9% reducing rate of interest for a period of 15 years, which comes out to be Rs. 43,106 per month. Further an additional Rs. 385,000 would be required for covering registration of your house property and loan processing costs. An additional cost of maintenance of house property at the rate of 1 per cent per annum of the value of the house is considered.

You on the other hand invest the same amount of Rs. 7.50 lacs in stock market index fund i.e. 7.50 lacs starting investment and a regular investment of Rs. 43,106 per month during the investment period.

After acquiring your house property, you decide to rent it out at prevailing annual market rent of 2 to 3 percent of the property value to start the income stream. Although you can get dividends in stock investments, we have kept it out of consideration as dividend rates and assurance of dividends are not guaranteed. Further, dividends are paid out on the face value of the stock rather than on the market value of single share of that stock.

At the end of 5 years, you decide to sell off your investment in both these asset classes. The net value in real estate investment means the realized value after repaying the balance loan amount.

Stock Investing vs. Real Estate Investing

Let’s compare the profitability of these investment options.

Year	Invested Amount	Stock Investment	Real Estate Investment
		Net Value	Net Value	Income	Costs
Year 1	1,267,276	1,370,190	1,414,042	156,000	438,250
Year 2	517,276	2,055,323	2,146,086	168,000	59,000
Year 3	517,276	2,812,197	2,953,109	186,000	65,000
Year 4	517,276	3,648,327	3,842,805	210,000	71,667
Year 5	517,276	4,572,010	4,823,658	234,000	79,083
Total Value	3,336,380	4,572,010	4,823,658	954,000	713,000

Particulars	Stock Market	Real Estate
Total Investment (Amount Invested + Costs)	3,336,380	4,049,380
Total Amount Realized (net value + Income)	4,572,010	5,777,658
Return	37.04%	42.68%

Stock investing: The stock investment would generate a return of 37.04 percent in 5 years. Over the long term the stock market provide a return close to 10 percent plus per year. In this example our assumed growth rate was 10 percent per annum, plain and simple.

Real estate investing: The real estate investment yielded a return of 42.68 percent in 5 years. You may however decide, not to rent out your property but in such case your returns may also drop considerably as the costs involved in maintaining the property will have to be borne by you as out of pocket expense. Although, we have assumed a 10 percent per annum growth in property prices, however, real estate has shown far greater appreciations in the past. Investments in property is considered a safer bet when it comes to investing as you are investing in a “real” asset.

Investment Liquidity

Most important differences in these two investment options is liquidity. Selling a property can be costly and time consuming. On the other hand, stocks offer high liquidity, meaning that you can sell a stock investment quickly and easily with low costs.

This difference is critical, as you need to have a very high holding capacity in case you are not able to sell your real estate investment at the desired price.

Further, Real estate properties require active management, and lack good liquidity as an investment. Although, active management is required if you are investing in individual stocks and have not invested in an Index fund (as in this example) or have taken the Mutual Fund route to invested in stock market.

Awareness is the key to maximize returns

You and I both know that when you invest money to make money your success really depends on how well you know and play the game, no matter what arena you invest money in. For example, if you are good at selecting, improving, managing and financing real estate properties you can do much better than the above example.

You can also make over 10 percent a year in stock investing if you know how to invest in the stock market. The problem for most of us is that we don’t know how to invest in stocks, we are uninformed. Hence, stock investing for most of us is a risky business.

On the other hand, traditionally many of us are comfortable with real estate investing because we are more familiar with real estate market (we see it every day and better understand the factors that affect the real estate prices around us). Real estate properties have historically gone up in value without many violent downswings. The stock market usually experiences a greater degree of volatility.

Stocks provide low risk high returns in long run

Time is money, is a one-liner that says it all when it comes to investing in stocks! Timing your investment is extremely crucial. But, does it really matter in the long run? What is the return that you can expect to make by investing in stocks over 1 year, 3 years, 5 years or 10 and more years?

In terms of investment ‘time’ perspective, in the short run the performance of equity shares is driven more by market sentiment than by company fundamentals. The correct time perspective for investment in stocks would be one that allows you as an investor to participate in and benefit from company’s growth. Keeping this in mind the ideal period to stay invested should preferably be greater than 5 years.

One would learn that in the long run, the relevance of the right price diminishes. If you choose the right company and have the right time perspective, in the longer term, it does not really matter too much whether you bought the share at the lowest price or not. This is because as long as the company is growing and you hold on to your investment, the Power of Compounding will multiply the value of your investment at a rate that will make the initial investment price insignificant. This makes a real mantra for wealth creation.

Taking the longer term perspective of staying invested for a period of 10 years and or more, you can expect stocks to yield returns ranging between 15% and 20% annually.

As unbelievable it may sound, an overview of the performance of Stock Markets over last three decades (see table below) confirms the same.

Historic Performance : Returns generated by Sensex over last 30 years

The table also shows the relationship between the period of investment and chances of loss. For instance, had you invested in the Sensex for any one year between 1979 and 2009, in 11 out of 30 times you would have lost money. However, if you would have stayed invested for more than 10 years your chances of loss would be almost zero. That too making a handsome average return of around 17% annually!

Conclusion

You may argue that this is historic performance of Sensex and it can not be taken as a measure to predict the future performance. Agreed, although future performance is not always dependent on the past performance, but there is no denying that it provides a track record of Stock Market performance over last 30 years. We can clearly see that as the time of investment holding increases the risk becomes lower and returns are higher than most of ’safe’ investment avenues.

Strategies for long term investment as markets correct

Investors remain concerned over the pace of the global economic recovery and have turned cautious in their approach to the markets, leading to profit-booking at every rise.

Although the results season was largely positive with most companies reporting earnings in line with or exceeding market expectations, it was weak global sentiment and consistent sell-offs by foreign institutional investor (FII) in last few trading sessions acted as a catalyst for the market correction.

The current rally in the domestic markets was driven mainly by liquidity owing to heavy inflows from FIIs who found the Asian markets poised for a recovery much ahead of their Western peers. While the domestic economy did not disappoint in terms of earnings numbers in the last two quarters, the current prices had already factored in the growth, thereby not leaving much room for a further upside. The market will now look for global cues to decide on the future direction.

The Reserve Bank of India (RBI) in the monetory policy, scheduled to be announced today (29/01/2010) afternoon, is expected to hike the CRR and Reverse Repo rates.

Over the short term, the markets could display increased volatility and this in turn could throw up attractive opportunities for medium to long term investors. While the long term growth story of the domestic economy remains intact, the short term will always be marred with uncertainty. Long-term investors would do well to use this uncertainty to their advantage.

Here are some strategies investors can adopt to ensure their portfolios remain aligned towards growth:

1. Review asset allocation

Investors should stick to their asset allocation across equity, debt and money market instruments depending on their overall investment profile. Reviewing the asset allocation when the markets peak gives an indication of whether to book profits in equity. As the markets correct, an asset allocation review will help investors decide on the amount which should be shifted back to equity in order to balance the asset allocation.

2. Maintain liquidity

Falling markets often present attractive opportunities but it can be made use of only if investors have money to invest. Re-balancing asset allocation can provide some liquidity to the investor and this can be used effectively to pick up desired stocks when the markets correct.

3. Selection of stocks

Stocks, especially in the large-cap category, had a major run-up in the past few months. For investors, it was a risky proposition to enter these stocks at the levels at which they looked more than fairly-valued. A correction in the markets has brought these stocks back to prices which are attractive for medium to long term investors. Hence, investors can identify their target companies and slowly start accumulating these stocks as the markets offer opportunities.

4. Stagger purchases

While the markets have been in a correction mode for the past two weeks, it is difficult to predict whether this phase is temporary or will continue for a while. Hence, it is important to stagger the purchases over a period of time rather than buying in one go. The expected volatility in the markets may give investors many opportunities to pick stocks at desired prices.

5 points to consider before investing in Penny Stocks

Penny stocks lure a large section of investors. Their acquisition cost is cheap (often in low single digits) and the upside potential is almost limitless. A mere couple of rupees or, in some cases, a few paisa rise in the stock price would double or triple your initial capital. On the flip side, purists and market pundits look down upon investments in penny stocks. And they have valid reasons to be skeptical about penny investing.

Most penny stocks are little-known companies with a poor track record of financial performance. Their business plans cannot be trusted or bought at face value, either. These companies can easily go into oblivion without any trace. This makes penny stocks risky bets in any market situation. You may make millions or end up forfeiting your entire capital.

But optimists consider risk as the other side of return. Greater the risk, larger is the reward. The returns on penny stocks, however, depend on the extent of diversification. This segment has a high mortality rate and the only way to reduce stock-specific risk is to start with a larger portfolio.

However, you can make a lot of mistakes if you’re not careful. Consider following points while preparing your penny-portfolio :

1. Do your own research : The low price of penny stocks can make it more tempting to invest in one or more stocks without doing your research first. Research is vitally important because you need to know whether you are investing in a good or bad quality company. Penny stocks do not appear on the main stock exchange and the companies may well be less established as a result. Don’t risk investing in anything until you have done your homework on it first.
2. Credible source of information : Watch your sources of information too. There are lots of websites online that give out free tips and advice on which stocks to buy and which ones to sell. Always ask yourself why another person should recommend something to you for free. Trust your own instincts and knowledge more. This comes back to doing your own research once again – you can’t get out of this aspect of trading penny stocks if you really want to stand a chance of making a profit.
3. Not every penny stock can make you fortunes : Another mistake is to think that profiting from penny shares is easy. You might just pick a good company that is about to enjoy massive success – but it doesn’t happen every day by any standard. Never assume that trading in penny shares will make you your fortune – you could lose a lot of cash through thinking it is easy.
4. Build a large enough portfolio : Diversify your risk and build a large portfolio of carefully selected penny stocks. Although the portfolio will have some losers, whose value might have become zero, the few stocks that eventually turn into multi baggers will significantly offset such losses and give superior returns.
5. Know your risk appetite : Always remember that penny shares are risky propositions. You can just as easily lose every penny you invest as you can make money. So before you buy into any particular company, make sure you are happy with kissing goodbye to that money should something disastrous happen. Save for a while to build up a pot you don’t mind losing if need be – but don’t bet the money you can not afford to loose on trading penny stocks. Ignoring your risk appetite could be disastrous.

You should also make sure you don’t rely on a broker to help you pick your stocks. Your own decisions, instincts and research take precedence over everything else, so make sure you remember this.

The Language of The Indian Stock Market

EverGreen

These stocks are steady compounders, churning out steady growth rates year on year. They are typically significant players in their markets, with sound strategies that will help them achieve and sustain market dominance in the long run. They have strong brands, management credentials and a consistent track record of achieving super normal shareholder returns. We expect stocks in this category to compound at between 18-20% per annum for the next five to ten years Also called ownership stocks, Evergreen stocks are the brightest jewels in any portfolio.

Apple Green

These are stocks that have the potential to be steady compounders and are attempting to move upwards, to turn Evergreen. They rank a shade below the Evergreen companies, only because their potential in the five to ten years' time is still not very clear, although they might grow at rates faster than that of the Evergreen stocks in the next year or two. They could grow at 25-30% per annum over the next two to three years.

Ugly Duckling


These are companies that are trading below their fair value or at values which are at a significant discount to that of their peer group, due to a combination of circumstances. But things are now starting to happen in these companies or in their markets that are likely to cause a re-evaluation of their prospects. These stocks could double in two to three years' time. Buy into an Ugly Duckling now and you'd have a beautiful white swan on your hands two to three years down the line.

Emerging Star

These are typically young companies, often in niche businesses, that have the potential to grow and dominate their niches. Even better, they might turn out to be real giants, if their niches explode into full-blown markets in their own rights. These stocks are potential ten-baggers but you need to be patient. Buy into these stocks and watch your personal star ascend!

Vulture's Pick

These are companies with valuable assets or brands that have been trashed to ridiculously low prices. Buy a Vulture's Pick and wait for a predator who finds its assets undervalued to come along. This could be a long wait but the returns could be startlingly high. The key is to be patient. The vulture after all is a patient bird.

Cannon Ball

Season's favourites! Typically they are fast gainers in a rising market, which could give returns of 20-40% within three months. Based on a combination of sound market information, technical charts and available fundamentals for investors with an appetite for high risk and high reward. So what are you waiting for? Get in and fire some Cannonballs!