Reblog: 40,000 times in hundred years = 11.3%

This hard hitting article is written by D. Muthukrishnan (Muthu). The original post can be found here.

I was reading this article written by Vivek Kaul.

A bungalow in Nepean Sea Road, South Mumbai was bought for around Rs.1 lakh in 1917. It is now going to be sold for Rs. 400 crores. The value of the bungalow has multiplied by whopping forty thousand times in 100 years.

Real estate is always discussed in terms of how many times it has multiplied. Rarely anyone in that industry calculates XIRR or annualised returns. 40,000 times in 100 years when expressed in terms of XIRR is 11.3%. Not a bad return at all. But nowhere as glamorous as saying 40,000 times.

Many tell me something like that the property they bought 25 years ago has multiplied by 10 times. Sounds fantastic. But the annualised return works out to 9.6%.

When I say Birla Sun life Tax Relief’96 has provided around 26% returns in last 20 years, it doesn’t sound much sexy. When I rephrase that the fund has multiplied wealth by 100 times in 20 years, it suddenly looks very attractive.

Generally, we the advisors always talk in terms of annualised returns. If I say, you may expect around 15% annualised returns from equity over next 20 years, what it means is that the money getting multiplied by 16 times.

Do one thing. Use the simple function in excel or a financial calculator to calculate returns in terms of XIRR. An exotic 10 times in 25 years would be converted into a modest 9.6% XIRR. Comparison between asset classes would become meaningless if not measured in the same way.

Learn to measure everything in terms of annualised returns. This would not only impart better financial literacy, it would also reset your expectations to more realistic levels. If a prime property in Mumbai can ‘only’ deliver 11.3% over 100 years, you would learn to be contended with 9% annualised returns from your real estate investments.

The 2004-07 bull market in stocks, the 2004-09 boom in real estate are more of exceptions than the rule. As I’ve mentioned before, in the long run, you may set your expectations as follows:

Fixed Deposits: Inflation + 1%

Gold: Inflation + 1.5%

Real Estate: Inflation + 3%

Equity: Inflation + 7%

Next time when you meet me, let me know how much annual returns your real estate investments has delivered over last 2 decades.

The number may surprise you.