Let’s first start with the objective of having alternative investments such as real estate and gold in your portfolio. For me, there are 2 main reasons:
· Inflation hedge because of positive correlation with inflation
· Diversification because of low correlation with stocks and bonds
Real estate: Real estate was and remains to be a favorite asset class for majority of Indians. I do feel that this should change though. For optimum asset allocation strategy, real estate shouldn’t be majority of your portfolio (which is currently the case for most people). It doesn’t mean that you shouldn’t buy a home. You should buy 1 home because it has a lot of emotional value, you save on rent, you have shelter in case things go south in your life, and potentially some price appreciation as well. That’s where the investment in home should end; you shouldn’t buy a second home as a source of rental income. If you look at rental yields in major cities in India, it’s about ~2–2.5%. Taking a bank loan of 10%+ interest rate to get a 2% rental yield and hoping the price appreciation in future is going to be massive is not a sound financial decision.
If there are gaps in your portfolio with respect to real estate allocation, you can explore the following investment options:
· Commercial real estate (generating >5% rental yield)
· Real Estate Investment Trust (REIT)
Gold: Gold is another favorite asset class for majority of Indians. I have my reservations about gold as an investment. It only performs well in an uncertain economic environment because people use Gold as a hedge against bad/uncertain economic condition.
To put things in perspective, let’s look at other investment options:
· Equity: You buy company shares, you become a shareholder. You basically own a part of the company
· Debt: You lend some money to corporate, governments and get fixed interest rate along with your principal
· Real Estate: You buy a residential/commercial property. You live there (save on rent) or you get rent as an income
If you look at gold, it doesn’t do anything productive. Its price appreciation depends on uncertain times and people seeing value in gold.
However, if you feel strongly about gold and gold investment is in line with your investment philosophy, my suggestion would be to keep it to 5–10% max of your total portfolio.
Among different gold investment options, here is my priority list (1. being the best):
1. Sovereign Gold Bond
2. Gold ETF/Mutual Fund
3. Digital Gold
4. Physical Gold
Sovereign Gold Bonds have zero expense and you also get 2.5% interest per annum on your initial investment. Only downside is the lock-in period, but that shouldn’t be a concern if your investment horizon is long term.
Between digital gold and gold ETF, I would choose gold ETF simply because of the expense. For gold ETF, expense ratio is around 0.5–1%. For digital gold, there are several cost components such as technology cost, hedging cost, insurance, and transportation cost. These costs are not obvious, but you will see them reflected in the bid-ask spread. Gold bid-ask spread ranges between 3–5%. Hence, hold ETF is a clear winner between the two.
Physical gold in the form of jewelry ranks the lowest as an investment. Making charges, commission charges at the time of selling, storage cost, etc. makes it the least efficient way of investing in gold!