Capital Account: Uma Shashikant

Are you creating right assets?

Creating assets is a goal that several investors set for themselves. The joy of investing in something that will grow in value with time is 

a source of motivation for saving. But do investors pause to ask what they expect these assets to deliver for them? Is the earning capability of the assets carefully considered? Not always.

For most households, the purpose of using today’s savings to create assets should be to generate an income from these later. The classic retirement equation is where assets generate adequate income to replace regular income. The need for regular income and cash for unexpected circumstances is a requirement of all households. Creating assets ensures that when there is a mismatch, you can fall back on these. The problem in many asset-creating strategies is three-fold: One, there is scant regard for the income generating capability of assets. Two, the ability of an asset to be used as a collateral is not evaluated. Three, sale is either a reluctant or distressing activity.

Several investors buy gold and gold jewellery, without considering that these generate no income. These can only be sold to realise the value, and many will vouch for how distressing this activity can be. An advantage is that gold is accepted as a collateral. But lending presumes income to repay the loan.

Consider the case of investing in property. After the property is bought, the rental yield is low for a long period. If it is well-maintained, it can generate decent rentals in future. That rentals are inflation-protected incomes is an added advantage. Using a product, such as reverse mortgage, enables generation of income from property, which is similar to using property as a collateral for generating income. However, property is such a large and chunky investment that it is tough to sell it for smaller requirements of income. Investment in equity, mutual funds, bonds, deposits and saving schemes have an advantage of serving all the three purposes mentioned above. These can be easily sold or pledged, and have a higher income-generating capability.

While constructing a portfolio, it is important to see whether the proportion of assets is meaningfully aligned to future income needs. Say you are running a company, and not a household. What will you do with your balance sheet? You will create fixed assets such as plants, machinery, land and buildings, so that these generate some current assets in the form of finished products from time to time. Any liability, current or loan, can be met only when the asset composition considers these needs correctly. Selling a long-term asset for a short-term liability is a suicidal practice, as finance managers will tell you. Similar logic comes to play when you construct a balance sheet of assets and liabilities. If your assets cannot be converted into, or cannot generate cash, you compromise the quality of your portfolio. If your portfolio has a large chunk of property and gold, it needs correction.

What about investors who buy and sell property, or dabble in trading commodities? They primarily have trading portfolios. Assets are not held to generate income but to be bought and sold frequently. Such portfolios require a good amount of capital and shrewdness to churn the assets. So, activities such as investing in property and commodities are in the realm of the rich, who can run such trading portfolios in high-value assets. It is not meant for simple households that are trying to build something of value from their income.

Many ask me how they can retire early. They either want to become entrepreneurs after 40 years of age or pursue a passion their working lives have denied them. Many have mindlessly bought properties with their savings. It makes little sense to have a teak plantation that needs to be slayed for its return. A mango orchard that will generate an yearly produce is a better bet.

Property tops the list of favoured assets. We will exclude self-occupied property as it neither generates rent nor is sold to realise the appreciation in value.

The writer is managing director, Centre for Investment Education and Learning. Views expressed are her own