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 wealth

As already mentioned, an RBI report found that gold, along with real estate, accounts for the largest share of Indian households’ wealth at 11 percent. An 11 percent allocation to an asset is a relatively large proportion by any standard. How has such a material asset allocation proven for Indian households? Over the past ten / twenty / thirty years the price of gold (expressed in rupees) has increased with annualized returns of 9.2 percent, 12.7 percent and 9.3 percent, respectively.

In the same period, an investment in the stock markets, represented by an investment in the BSE Sensex Index, achieved a return of 10.4 percent / 15.0 percent / 14.8 percent or more than gold in each period. If we look at the returns on gold in each of the three decades over the past thirty years separately, we see that gold has lagged far behind the Sensex. In the 1990–2000 decade, gold prices rose with an annualized return of only 2.8 percent and didn’t even beat inflation. The smallest margin that gold underperformed was in the 2010-2020 decade, when the price of gold rose 9.2 percent a year, versus 10.4 percent for the Sensex. However, during that decade, gold prices have been more volatile (as measured by standard deviation) than stocks, suggesting that there was no compelling reason to own gold on a volatility-adjusted basis.

Even if gold does not generate higher returns than stocks, if it correlates negatively with stocks (thus allowing you to diversify your returns) it could improve the risk-adjusted returns of your portfolio. The widespread public perception is that gold is negatively correlated with stocks. However, the data on this is actually mixed. While gold has been negatively correlated with the Sensex for the past decade, the negative correlation drops over longer periods of time, namely twenty and thirty years, and actually becomes a mild positive correlation. This means that gold prices and the BSE Sensex have moved more or less in parallel over the past twenty and thirty years. Also, if we divide the last thirty years into three decades, we see that gold has been positively correlated with stocks for most of the time. This means that the use of gold as an asset diversifier does not work consistently either. Overall, it is difficult to argue that gold is a significant part of an Indian investor’s portfolio.

The RBI report mentioned above also confirms these results and advocates a shift of assets from gold to other financial assets. The reports say:

In households that hold larger amounts of gold, i.e. in the upper third of the cross-sectional distribution, the current annual income gain from the shifting of a quarter of their gold holdings into financial assets is 3.4%, which in terms of capitalization means an upward movement of around 5 percentage points along the Indian wealth distribution . These projected profits are almost always above zero, even when we factor in the volatility that can result in different returns on gold and financial assets.

Myth 2: Real estate will help me grow my wealth

If one looks at the return on real estate in Indian metropolises such as Mumbai, Delhi and Bengaluru over the past five years, the returns were around 3-4 percent per year; that is, house prices have at best kept pace with consumer inflation. Properties in major markets like the National Capital Region haven’t even made it.

However, there is a mindset in India that says that residential real estate returns have been weak for the past five years, they will be better in the future. This point of view cannot be upheld by comparing Indian house prices with prices in other markets. The first problem is affordability. Housing prices in India, expressed as a percentage of GDP, are 6 to 10 times the prices found in some comparable Asian economies.

Second, residential rental returns in India are around 2-3 percent in most Indian cities, while the cost of a home loan for prime residential customers is around 7 percent. The discrepancy between these numbers suggests that Indian residential real estate still has scope to correct its highs before it becomes an attractive asset class.

Third, comparing residential rental returns in India with returns in other countries suggests that the Indian residential real estate market is significantly overvalued. Other markets that have rental returns comparable to India’s – such as Singapore and the United States – have borrowing costs in the 2-3 percent range. In contrast, in India, as mentioned earlier, the cost of a home loan is much higher, at around 7 percent, even for a prime customer. In fact, the cost of a home loan in India is significantly higher than in Indonesia (7 percent versus 5 percent), although rental returns in Indonesia are much higher than in India. It is clear that investing in real estate in India doesn’t make much economic sense. Add other factors – like high transaction costs (broker, stamp duty, etc), illiquidity (your property is pretty much useless for funding emergency cash calls), and a lack of transparency in determining its 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 is published with the kind permission of Penguin Random House.

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