While creating a portfolio, there is always a toss-up between what assets to invest in -- be it asset classes or the nature of the asset (i.e. physical or financial). Physical assets such as gold and real estate have their own positives and negatives, while other financial assets such as mutual funds, stocks and bonds come with their pluses and minuses. Let us look at both options in a little more detail.
Physical assets
These are typically investments that you can touch and feel, and are normally either real estate or gold. Both of these are considered safe investments -- although this need not always be the case. In the instance of real estate, there is a scope for capital appreciation, as typically the longer one holds on to properties, higher the capital appreciation. There is also the benefit of rental income and the fact that real estate gives the investor some sense of security.
However, there are several disadvantages to real estate such as the legal issues, which can be complex and an investment in land, must be considered only if an investor has a thorough understanding of these.
Sometimes the land may be mandatorily acquired by the government for state development which sometimes even leads to a loss, as the compensations are low. Also, this asset is highly illiquid and cannot be sold as quickly as stocks or bonds.
Another fact to keep in mind is the high maintenance cost, especially in urban areas house property owners are required to pay maintenance charges to co-operative housing societies for common facilities -- like lifts, security, water, common lighting, etc.
Similarly in the case of gold, the physical purchase of gold has both ups and downs. Physical gold is one of the most popular forms of investing in gold, with India being one of the largest global consumers of gold. The most favoured form of physical gold is of course jewellery, and this is followed closely by gold coins and bars.
One needs to ensure that the gold bought is genuine and of good quality, as well as ensure safety of gold on an ongoing basis -- be it at home or a bank locker. Gold is also considered to be de-risking assets when equity markets are not doing well.
Hence, physical assets are good to invest in, as long as you have the bandwidth to do your research and take adequate measures to ensure safety of the asset.
Financial assets
In today's digital world, these are in e-form, and comprise of all types of financial instruments from bonds to stocks to fixed deposits to mutual funds. There are several benefits to owning financial assets over physical assets, such as lack of safety concerns since all the assets are in electronic form.
Apart from the diversification possible, and the ease of selling of the asset -- resulting in more liquidity, these assets also offer options to invest in traditional physical assets, albeit in an electronic form.
For instance, real estate investments can be done via REITs (real estate investment trusts) and gold investments can be done via e-gold or gold ETFs. These give you the same returns as owning the physical asset without the downside of having security concerns or even having to do in-depth research before investing.
REITs negate the need to hold physical real estate. This is similar to gold ETF vs physical gold: REITs invest in real estate and pass through rental and appreciation benefits, but one does not actually own the property, and cannot develop/ sell/ etc. the underlying property.
Final thoughts
At the end of the day, there needs to be a judicious mix between physical and financial assets. One can buy property to live in and maybe to rent, and post that invest via REITs, and can buy gold only for jewellery and investments can be done via e-gold / gold ETFs. However, the physical assets are core to a properly diversified portfolio.
Summary:
- Physical assets give you a sense security but may have liquidity concerns
- Financial assets are typically electronic
- Both need to be part of a balanced portfolio
Photograph: Scott Branson/Creative Commons
Anil Rego is the founder and CEO of Right Horizons, an investment advisory and wealth management firm that focuses on providing financial solutions that are specific to customer needs.
