The assets that are easy to understand are those in which you know how much returns you are getting. So you keep a fixed deposit in a bank, the bank tells you that the FD is for 5 years and you will get 9.25% as return.
Ditto for PPF, Kvp, nsc…
However when it comes to Real Estate or Equities, the returns are not so simple to calculate. Recently met a middle aged couple who were very proud / happy with their RE investment in a distant Mumbai Suburb called Kharghar. I AM NOT COMMENTING about the quality of choice of location or investment decision, this is just an explanation of innumeracy.
So I asked them how much are the returns that they had got in that investment. The wife looked towards the husband and he said – ‘clearly about 20% p.a.’. I said during the period 2007 to 2014 I do not think that the return was 20% p.a., but let us take a look.
He had bought the house in 2007 for Rs. 35 lakhs – out of which about Rs. 15 lakhs was borrowed (and he is still paying the EMI, of course). He had paid the builder almost all the money and he got it registered in his last week.
The Math is as follows:
He had paid about 35,60,000 in 2007 to the builder and he was paying an EMI of Rs. 15000 to the lender. He paid about 3.5L in 2014 to get it registered, and now the flat is available for occupation. The RE broker has told him that at best he can expect Rs. 7k as rent (this to me is a stunningly low rent yield on current market prices estimated to be between Rs. 65L and Rs. 70L).
So how much is the return, once more Mr. S? Well your mind tells you it is 20%, but if your money has LESS THAN DOUBLED in 7 years – it is a yield of about 10%p.a.
This at a time when he has been paying EMI on a loan which is currently costing him about 11% p.a.
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