How to invest smartly to buy a house in 5 years?

How to invest smartly to buy a house in 5 years

For a person who has been employed for a few years and has taken care of his basic necessities of food and clothing the next big thing that he seeks to get is a house. This is especially true for those individuals who leave their home town and get employed in other cities.

would investing in share market online help traders to own house 5 years down the line

But buying a house is easier said than done. Given the real estate prices in cities it is very difficult for a young person to think of raising funds to buy even a small house.

Margin Money

Even though there are bank loans available to finance a house they do not completely finance the house. There is a base capital that is needed to buy a house, which is generally between 20-25 percent. Banks and other financial institutions finance between 75-80 percent of the house value.

In some cases, banks also consider various taxes for calculation of value of house that is to be financed. Taxes can increase the price of a property by around 10-15 percent, depending on the city where the property is to be purchased.

Earlier, there used to be a sizeable cash component in property deals, but thanks to demonetisation and stricter monitoring use of cash has reduced substantially and in cash where renowned builders are involved it has completely vanished. A house buyer thus has to only concentrate in raising the margin money needed so that he or she becomes eligible for a loan.

But again this amount itself is sizeable. In cities like Mumbai a small one room flat costs upward of Rs 1 crore, that too in distance suburbs. For the potential house owner it is then a question of raising anywhere between Rs 20–25 lakh for the margin amount only. He will need an extra Rs 5-10 lakh to do the basic furnishing of the house. We are thus talking of an amount, say Rs 30 lakh to be raised to buy a house.

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Also Read : Does Buying a Home Score Over Investing in Stocks?

Present value of margin money

Now if someone plans to buy a house say 5 year from now, he will have to have a plan in place so that his present capital will become Rs 30 lakh in 5 year time. Investing in a debt instrument to meet the target of Rs 30 lakh is not an option because one has to consider the rise in house property over the next five years.

In India house property have been rising at around 10 percent per year. A debt investment normally yields around same kind of returns, hence the individual will have to find an instrument that case give him a better return than the rising real estate prices.

The only such investment is shares.

One might feel that this a risky investment and chances are that rather than raising incremental money probability of losing the savings is higher. However, smart investing options can help raise the desired amount within the given timeframe.

The first thing the note is what is the starting capital that is needed and what is the desired return to achieve the margin amount needed for buying a house.

Equity investment, especially in indices have grown at a compounded annual growth rate of 17 percent. Based on this knowledge one can calculate the present value of future need.

Using a discount rate of 17 percent, period as five years and future capital as Rs 30 lakh the present value turns out to be Rs 13.68 lakh.

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So if a person has Rs 13.68 lakh he can invest in an index fund and hope to touch the Rs 30 lakh mark in five years.

However, timing the market is equally important. If the person invests near the peak of the market, and the market falls after his investment, chances are that the level of Rs 30 lakh will take longer to achieve. Generally bear markets in India have not lasted for five years, they will still have to rise substantially from the bottom of the bear market for the investor to recover the amount.

Also Read : Fixed Deposit v/s Equities – Which is better?

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Dividend yield play

A better option and one where capital can also be relatively protected is to look out for stocks giving better dividend yield.

Companies which give a dividend yield of over five percent as considered to be good targets for long term picks. Since dividend income is tax free at five percent yield and above they become comparable These level of dividend yield acts as a base for the company’s share price as many buyers will be attracted to invest in such stocks.

As the stock market improves these stocks have to move only slightly to start retuning above normal returns. The overall yield of capital gains and dividend yield results in a better than index return. The only problem with dividend yield investing is that there are very few opportunities in a year, especially if the stock markets are in a bull phase.

Thankfully there are other options which are equally good and in some cases better than dividend yield investing.

Other Ideas

One of them is investing based on the ratio of market capitalization of the company to its cash flow. Companies with positive free cash flows are liked by investors as they generate over and above the money needed to take care of their expenses, pay debts, take care for expansion and even after paying dividend there is enough left in the kitty for future exigency. Market capitalization is the multiple of stock market price and its equity.

A lower number of the ratio of stock market capitalization to cash flow is desirable. Suppose a company has a cash flow of Rs 100 crore and its market capitalization is Rs 300 crore the ratio is 3. One way of looking at the investment is that if someone wants to buy the entire company it would take Rs 300 crore but the same amount can be recovered in three years if the current cash flow is maintained. Such companies offer better than stock market returns in the medium to long term.

There are many such ratios that can help an investor in picking up stocks when they have fallen down and offer good protection of capital. For a person who intends to purchase a house in future, protecting his capital is as important as higher returns. Smart investing can help the person meet his goal of buying a house.

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