Financial Assets vs Physical Assets- Striking the right balance

The views and opinions expressed are of Mr. Arun Thukral, MD & CEO, Axis Securities.

Assets that one can feel, see, touch or hold are called physical assets e.g. Real Estate, precious metals, jewelry, plant and machinery, vehicles, tools etc. Physical assets require maintenance, repairs and upgrades which involve expenses. The Financial assets are intangible assets that cannot be seen or felt except for the documents, if any, that represent ownership interest in the said asset e.g. shares, bonds, corpus held in bank deposits, account receivables, goodwill, copyrights, patents etc. Financial assets do not incur any depreciation or loss of value due to wear and tear. However, the financial asset may appreciate or depreciate in value terms depending upon the market conditions. 

Now let us limit ourselves to an individual investor’s portfolio for discussing the physical and financial assets and its share in his portfolio.  Let us exclude the assets like living house, vehicles and jewelry from the portfolio as these are purchased for consumption.

We, Indians are fond of physical assets, be it Real Estate in the form of agricultural land, plots and developed Real Estate or bullion. The affinity of Indians to these physical assets can be attributed to lack of alternative instruments in financial asset side. Though, BSE- the leading stock exchange has more than 100 years of existence, the official index has a history of around 38 years- the base value of BSE Sensex is taken as 100 on Apr. 1, 1979. Earlier, the trading in stock exchanges was limited to few cities like Mumbai, Delhi, Kolkatta, Ahmedabad, Madras etc. Over last 15-20 years, the financial markets have grown from level to level and now have become an asset class that can be reckoned with. With the advent of information technology, telecommunication and internet, the exchanges have made deep penetration over past couple of years. The mindset of an average Indian is now changing with a tilt towards financial assets.

Let us compare the 2 types of asset classes. The physical assets viz., the Real Estate and Bullion are hedge against inflation. Among the two, the bullion offers no income other than value appreciation in case of uncertainty but it has an appeal in the society and is looked up as an asset of last resort in case of emergency. Storing of precious metals involves cost. Warren Buffett had derided Gold as an asset class- “Gold gets dug out of the ground in Africa or someplace. Then we melt it down, dig another pit, bury it again and pay people to stand around guarding it. It has no utility”. Hence, one should buy Gold or other precious metals only to the extent needed for consumption.

Being a growing economy, Real Estate- both commercial and residential- has latent demand. Real Estate is an income generating asset, but the yield differs from location to location unlike financial instruments. The demand drives the value appreciation in Real Estate, and since the demand differs from pocket to pocket, the appreciation and rentals vary in different cities and different locations in same city/ town. Real Estate also requires periodical maintenance or uplift and involves legal hassles including expenses at the time of letting it out. Investing in Real Estate requires huge sum of money at the time of investing. Hence, this asset class becomes relatively less investor friendly as compared to bullion and equities, where one can invest in small amounts as and when one has surplus money.  

Physical assets markets are illiquid; these assets are relatively difficult to be monetized at the time of need. The market for both bullion and Real Estate is opaque and thus lack transparency. These asset classes are not regulated; there are no market makers for these asset classes and hence, the counter party risk always persists at the time of transaction. 

As against, the financial assets, be it shares of a listed company or fixed income securities, offer cash flow in form of dividends (for dividend paying shares) or interest payments for fixed income securities. If invested after proper due diligence, the shares offer capital appreciation over a period of time and the fixed income securities return the principal on maturity. Since equities have historically beaten the inflation by wide margin, it has helped in wealth creation over long time period despite the volatility due to different factors. The domestic index, Sensex has multiplied ~7x over last 16 years starting 2001 till 2016 giving a compounded annual growth rate of ~13% over the same period. Equities offer, what is called the magic of compounding which enables the invested corpus multiply over long period of investment. Conclusion, Equities beat other classes in nominal terms despite volatility involved. Hence, if one wants to create wealth, he should resort to equity investment for long term. 

The storage of financial assets/ instruments is far easy, safe and cheaper than bullion and requires no maintenance like Real Estate. The transactions in financial assets is completely transparent and quick given that the exchanges act as market makers and no counter party risk exists at the time of liquidation. The markets are regulated by the Apex body which has designed the rules and regulations to ensure smooth functioning and transparency in operations. Hence, the financial assets score over the physical assets as an investment avenue. 

Another advantage for financial asset is that one can create a portfolio by investing small amount say Rs 500 on monthly basis in SIP. One can shop for even one share of the company irrespective of denomination and endeavour to build a portfolio over long time using small investments on regular basis.

The financial markets are hugely volatile in nature. The market valuations of the instruments have an influence of domestic as well as global developments on daily basis. Unless one is long term, patient investor and has sufficient time to invest in study of the investments or has access to experienced and seasoned advisor, it would not be advised to invest in financial instruments esp. equities. 

Now how should your portfolio look like? The basic aim of investment is wealth creation. Equities, by far, have consistently created wealth over long period of time. Thus, financial assets and equities, in particular, should share highest share in your portfolio. Having identified your target goals at pretty early age of your work life, one should create portfolios tailored to meet those specific goals.  Define your risk profile for every portfolio based on the goal and the time period given to meet the goal and accordingly design the constituents giving an overweight to equities. As, Real Asset and Bullion- are hedge against inflation, the wealth created by these assets relatively lags behind the wealth created by the financial instruments esp. equities. Hence, it would be advised to start your investments using the financial instruments/ assets to build your wealth bit by bit so that after it grows into a substantially large corpus, one can invest in the physical asset like house and enjoy the fruits instead of doing the other way round.