When it comes to choosing where to invest our money, it's not just about the numbers. Our emotions and perceptions also play a significant role in the decision-making process. This is especially true when it comes to real estate investment, where the allure of owning a physical property and the potential for income and appreciation can be tempting. But what exactly is it about real estate that makes it such a popular choice, and how does human psychology factor into the equation?
In this article, we'll explore the psychological factors that may influence an individual's preference for real estate investment over other options, such as mutual funds. We will also try to highlight the facts about real estate and mutual fund investing that a prudent investor must consider before investing.
Human psychology plays a pivotal role in real estate investment and preference for it over other types of investments, such as mutual funds. There are a few reasons why this may be the case:
Emotional attachment: Many people have an emotional attachment to real estate and may view it as a "safe" or "stable" investment. They may feel more comfortable investing in something tangible, such as a property, rather than a financial instrument like a mutual fund.
Perception of control: Investing in real estate may give people a sense of control and the ability to directly influence the performance of their investment. For example, they can make renovations or improvements to a property that may increase its value.
Familiarity: Real estate may be more familiar to some people, as it is a part of everyday life. They may be more comfortable with the idea of investing in real estate because they have experience with buying and selling properties or have a general understanding of the real estate market.
Real estate is considered to be a relatively stable and low-risk investment, compared to mutual funds due to the market risk in the latter. Real estate being a tangible asset can appreciate in value over time, and can also generate rental income. However, real estate investing carries its own set of risks and uncertainties, such as changes in market conditions, property valuations, and tenant demands.
The psychological appeal of owning physical property and the potential for large appreciation in value may lead people to be more committed to real estate investments, even if they do not always perform as well as mutual funds in terms of returns.
Consider this example:
Let's say you want to buy a property worth Rs 50,00,000 and you have around Rs 10,00,000 (from your savings) which you paid upfront for the property. For the balance Rs 40,00,000, you take out a loan with a monthly EMI of INR 39,390 for 15 years, assuming interest rate of 8.5% p.a. Including the repayment of principal and interest, your total purchase value of the property comes to Rs 80,90,125. At the end of 15 years, when you finish paying off your loan, the property value increases to, say, Rs 1,50,00,000. You would be pleased with this outcome as it represents a significant increase in value. However, if you were to start and continue to invest INR 5,000 per month via systematic investment plan (SIP) in an equity mutual fund, at the end of 15 years you would have invested Rs 9,00,000. Assuming a compound annual growth rate (CAGR) of 12%, you would end up with a corpus of Rs 25,22,880.
In this example, the amount invested in equity mutual funds is almost 9 times less than the amount invested in real estate. However, people often view mutual fund returns as lower because they expect higher returns from funds that invest in equities. In reality, the CAGR of the property in this example is only 7.6%, while the mutual fund investment generated a CAGR of 12%.
Since mutual funds can be bought and sold more easily and quickly, they are typically more liquid than real estate. It is easier for mutual fund investors to track the value of their investments real-time using the net asset value (NAV) of the fund that is updated on a daily basis. The positive and negative changes in NAV make investors anxious and they can consider liquidating their investments in mutual funds.
In contrast, real estate can be more illiquid, as it can take longer to buy or sell a property and realize the investment returns. This can make it more difficult for investors estimate the value of their investment. In fact, value of property can be known only in the event of buying or selling it. Some investors may choose to hold on to their real estate investments for longer periods of time, even if the property values are declining, due to large initial investment made and conventional wisdom that real estate prices generally rise in the long term.
Time in the market is an important factor in any investment’s performance. By holding an investment over a longer period of time, an investor can potentially smooth out the impact of market fluctuations and volatility. This is because the value of an investment can fluctuate in the short term, but may trend upward over a longer period of time. However, investors frequently switch in and out of the mutual fund and this can affect the mutual fund returns. Such frequent switching is not possible in case of real estate due to their illiquid nature and investors tend to be more patient and be invested for longer period in hope of higher prices. In fact, if real estate investors consider buying and selling property as frequently as they do in case of mutual funds, they are likely to suffer much higher losses.
There are several factors that can make mutual fund investing more beneficial compared to real estate investing. Some of these factors include:
Investment Amount and Horizon:
Mutual fund investments can be made with a very small amount as compared to real estate investment. One can invest in mutual funds for short, medium or long-term depending on one’s financial goals. Investment in real estate has to be made from a long tern point of view as frequent churning of real estate portfolio can increase the probability of incurring huge losses.
Diversification:
Mutual funds offer the ability to invest in a diverse range of stocks, bonds, and other securities, which can help to spread risk and potentially reduce volatility in an investment portfolio. In contrast, as large investment is a prerequisite, real estate investing is typically more concentrated in a single property or a small number of properties, which can increase the risk of potential losses if the value of those properties decreases.
Liquidity:
Mutual fund investments can be more easily converted into cash compared to real estate investments. Although an exit load may be levied on early exit by mutual funds, they are still more liquid than real estate. This can make it easier for investors to access their money when they need it or to rebalance their portfolio as market conditions change.
Professional management:
Mutual funds are typically managed by professional fund managers who have the expertise and resources to research and select investments for the fund. This can help to mitigate the risk of poor investment decisions and potentially improve returns for investors.
Lower costs:
Mutual fund investments often have lower costs compared to real estate investments, including lower transaction costs, management fees, and other expenses.
Simplicity:
Investing in mutual funds can be relatively simple compared to real estate investing, which can involve a more complex process of finding and evaluating properties, securing financing, and managing the property.
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