We all want our investments to be profitable and deliver good returns. But how do we evaluate profits on investment? Is it a simple selling price minus cost price of the investment? Or is it not simple as it sounds? Is there a sure way to know if your investments are really profitable?
The investments in question can be anything that deliver returns which can’t be predicted – like equities, mutual fund, gold etc.
Let us consider an example:
(Assuming Indian context)
Suppose you buy a house for Rs. 1 Crore and sell it for a modest profit of Rs. 20 lac, at Rs. 1.5 Crore after 5 years. Is this deal really profitable?
Prima facie – YES.
Small amount, but still, profitable.
But then, let’s look at the numbers more closely.
Assuming that this apartment was bought just at the time of completion (hence no GST) and was rented out immediately.
- There will be a registration & stamp duty cost associated. While this varies according to the place, at 6%, this become Rs. 6 Lac.
- If it is an under construction property then there will be GST. Here I have assumed that you bought the house when it was just constructed and you were spared of GST.
- There was a one-time club membership f Rs. 1 Lac, which you paid.
- You didn’t furnish it or did any interiors, but basic fixtures – fans, tubelights, window grills etc. – Rs 1 lac
- You paid a maintenance bill of average Rs. 4500 per month (That’s close to Rs. 2Lac overall). Let’s assume that property tax and other small repairs will also fit within this.
- Suppose you took a Rs. 50 Lac home loan for this – … You paid 62 Lac EMI over 5 years. Use any online calculator and find out.
Here is the income you earned from the apartment:
- At 3% rental yield you would have gotten Rs. 25,000 a month i.e. Rs. 15 Lac over a duration of 5 years. Assuming 100% occupancy, and no brokerage (highly unlikely assumptions, but still …)
In 5 years,
- You have spent Rs. 1.12 Crore (112 Lac) on buying the house (including home loan EMI) & another Rs 8 lac getting it ready, and Rs 2.5 Lac in maintenance – Total of Rs. 1.22 Lac
- You earned Rs. 15 Lac with rental income with out highly optimistic assumptions.
- Since you sold it for Rs. 1.2 Crore, you made a net profit of (selling price + rental income – cost of house – other expenses) – A neat Rs. 13 Lac.
- There would be little tax benefit in home loan, which may be offset by the tax you need to pay on rental income. This may be a small number to matter in the larger context.
So here is the profit. A profit of Rs. 13 Lac!
(Related – Real cost of buying a home for investment)
Is this deal really profitable?
Using similar rationale,
Is buying a stock for Rs. 1,000 today and selling for Rs. 1,000 after 3 years really profitable? It seems so, but what vis a vis a simple plain vanilla fixed deposit which give better returns.
Or selling gold at cost price 2 years after buying and at cost price profitable?
Disclaimer – I am not doubting the rationale of stocks/ stock markets. They have potential to compound your money at a good rate. At the same time, there is no guarantee that these fixed deposits or other “fixed” returns instruments will offer the same rate of returns. It may or may not happen!
I am just curious to understand what should be the benchmark for profitability?
Should it be simple selling price (minus) cost price or should it also be the time value of money during this period?
The objective of this post is to ask questions rather than provide answers – there may not be any universally applicable answer, by the way!
Some random thoughts on this posts were lying in “drafts”. This post on Subramoney in a way pushed me to complete this and publish.
I had shared some similar thoughts some time back on – What ROI should you be chasing while investing?