Don't forget opportunity costs while investing

Sapna Mishra had been waiting to sell her flat in a suburb in Mumbai for more than seven years now. She was waiting for the right price and refused to sell at a lower price.

The right price according to her was Rs 1.5 crore while she kept getting offers of about Rs 1 crore. Incidentally, many others in her area had sold similar flats for Rs 1 crore, but she decided to hold on till she gets a price of Rs 1 crore. Due to the prime location of the flat, she believed that any builder who offers to re-develop the property will pay a good price (of about Rs 1.5 crore) for her flat.

She also thought that since she earns a rental income of about Rs 20,000 after deducting expenses, she is not really incurring any loss by choosing to hold onto the flat.

But experts differ. "Sapna would have made a lot more money if she had sold the flat and invested the same even in simple bank fixed deposits,'' points out PV Subramanyam, chartered accountant and financial advisor.

Currently, her flat of Rs 1 crore, at a monthly rental of Rs 20,000, results in earnings of Rs 2.4 lakh per year. If she had invested the corpus of Rs 1 crore in bank fixed deposits, she could have earned minimum Rs 8 lakh a year (considering a rate of return of 8%). If invested wisely, she could have earned even more.

Sapna's story is not an isolated case. There are many who are in the same boat like her. Many stock market investors get fixated on a particular price or rate of return for their investments. They end up making higher losses as they continue to hang on to a stock because they are waiting for a better price.

"The problem is that such investors fail to calculate the opportunity cost,'' points out Subramanyam.

Opportunity cost is the benefit that could have been gained from an alternative use of the same resource. For instance, you buy shares that give you only a 5% return in a year. Suppose you were to invest the same money in the debt markets where the returns were higher at say 9%. Then the opportunity cost in such a case is your actual returns less the returns that you could have made from the debt market, that is, 5% - 9% = -4%. Thus, the opportunity cost is -4% in this example.

In Sapna's case, the opportunity cost is Rs 8 lakhs – Rs 2.4 lakhs = Rs 5.5 lakhs.

The other aspect of Sapna's problem is about the long waiting period for re-development of the building in the hope that it would fetch a better rate. Incidentally, had Sapna invested the Rs 1 crore across different asset classes, she could have ended up with a corpus of Rs 1.5 crore from investments.

She could have deployed part of the funds in index funds such that they earned about 10-12% while a part of the funds could earn an assured 7.5-8% from bank deposits. "Her investment portfolio would depend on various factors including her age, marital status, financial status and financial goals,'' Subramanyam said.

The financial plan should be worked out in consultation with a financial planner who would take into account all the factors while suggesting a plan.

Adhil Shetty, CEO and co-founder Bankbazaar says, "Investments- be it short, medium or long-term should be goal-based. Your goal can be to build a corpus for anything from funding your higher education to funding a holiday to buying a house or car. Choose the right investment vehicle and do not try to time your investment.''

The other issue is whether the returns would be higher from a redeveloped property? "The question here is whether the returns from real estate exceeds 8%,'' says Subramanyam.

"Having waited so long, flat owners should wait for some more time. Following recent developments, re-development projects that had been stalled for a long time, may now see some action in April or May,'' says Shankar Tripathi, MD & CEO, Aadhar Housing Finance.

Subramanyam is not in favour of locking up funds in an illiquid asset like real estate. "If she ever needs the funds for an emergency, she can break a few FDs for the same. But real estate investments do not help at such a time," he added.

Source: DNA Money