Stocks, bonds, gold or real estate this year? Raghuvir Srinivasan on the best investment options for 2012.

Someone's sitting in the shade today because someone planted a tree a long time ago.

Warren Buffett, legendary investor.

If you are someone who tried to follow this advice in 2011, chances are that the seed that you planted failed to even germinate! Given the turmoil in global financial markets, it would have been a challenge even for the Oracle of Omaha, as Warren Buffett is known, to multiply his money in 2011. Why talk about lesser mortals like us?

So, what does the picture look like in 2012? Should you buy stocks? Or should you be conservative and go for debt options such as fixed deposits and bonds issued by government companies? Or will it be wise to stick to that time-tested investment — gold? Let's examine how the picture looks for each of these investment options.

Stocks: Investing wisely

The last year was a wash-out in the stock markets. No matter how savvy an investor you were, it was very difficult to make decent money as the market was on a consistent downtrend. Yet, with most major stocks lying battered and bruised at the moment, you may actually be sitting on a good buying opportunity now.

As Warren Buffett once said, the time to get interested in the stock market is when no one else is. The mistake we often do as investors is to get excited about stocks when everyone around us is excited too. Herd mentality is a dangerous attitude to have in the stock market, as often those who generate the excitement about all the wrong stocks exit them quickly leaving the rest holding duds.

The stock markets are now dull due to reasons such as high interest rates, slowing economic growth and the problems in major economies worldwide. However, we seem to be at the cusp of a change for the better, at least in the limited context of India. Interest rates have probably peaked and they can only fall from hereon, which is good news for borrowers. We will have an indication of the Reserve Bank of India's thinking on this later this month when it announces its monetary policy.

Industrial growth is on a roller-coaster but given that ours is a consumption-driven economy, a fall in interest rates will set off a virtuous cycle of higher demand, rise in output and growth in investment to meet the demand. This should be good news for the stock market.

So, it may make sense to start investing systematically in carefully chosen shares now. The stock market is dominated by big players such as mutual funds and foreign institutional investors. Volatility in prices has considerably increased, making it a dangerous place for small investors like you and me to directly invest in shares.

It may, therefore, be prudent to invest in the stock market via mutual funds. Choose diversified funds or those that track the major indices. If you don't need regular dividends, then invest in growth schemes that will offer you a higher return over the long term.

However, if you prefer investing directly in the stock market, choose blue-chip stocks that form part of the major indices such as the BSE Sensex or the Nifty, which is made up of shares of 50 top companies. Most of the blue-chips that constitute the indices are now available at attractive prices.

One word of caution though. Don't put money that you might need in the next one year in the stock market. You need to give more than a year for your investment in shares to generate a good return. And yes, unless you can watch the shares that you invested in decline by half without having a heart attack, you should not be investing in shares. Those are words of wisdom, again from Warren Buffett.

Debt instruments: The safer bet

This is an opportune time to invest in debt instruments such as fixed deposits, bonds issued by different companies and in mutual funds that invest in debt. Interest rates are probably at their peak level and it will be a good idea to lock into these rates now for the next 2-3 years.

A number of companies are offering good rates of 10-11 per cent on fixed deposits now. Pick only the ‘AAA' rated companies which are the safest even if the interest offered is relatively lower compared to an ‘AA' rated company. Of course, interest on these deposits is taxable. So, if you are someone in the 30 per cent tax bracket, your post-tax return will be between 7 and 7.7 per cent only, which is lower than the inflation rate.

A slew of bond offers from government companies are now in the market. The National Highways Authority of India (NHAI) and Power Finance Corporation (PFC) closed their offers last week. With an interest rate of 8.2 per cent for a 10-year term, these bonds offered the twin advantages of being tax free (interest) and also liquidity in the sense that you can sell them in the market if you needed funds urgently.

Never mind if you missed these two offers. There are equally good ones that are open for investment now. IDFC, an infrastructure finance company, and L&T are currently in the market with bond offers. These 10-year secured bonds offer 8.70 per cent interest which is taxable. This means that for someone in the highest tax bracket, the post-tax yield will be just 6.09 per cent. But the benefit is that up to Rs. 20,000 of your investment is eligible for tax deduction under section 80CCF of the Income Tax Act.

There are also unsecured bonds currently on offer from Rural Electrification Corporation and IFCI offering 8.95 per cent and 9.09 per cent interest respectively, which is again taxable but the investment is eligible for 80CCF deduction. Though unsecured, these bonds can be considered for investment since the companies are ‘AAA' rated with the government being their dominant shareholder.

Don't forget bank fixed deposits too. If you already have invested in them, ask for a reset of the interest rates. This will mean that you will have to invest for a fresh term from now but it will be worth it because rates are expected to fall and when your deposit matures a few months from now, you might get a lower rate if you choose to reinvest.

Interest from some long-term bank deposits of five years or more is exempt from tax. Also remember, most banks and some companies offer a higher interest rate for deposits made by senior citizens.

Gold: The perennial favourite

Gold is an evergreen investment option and certainly THE choice during difficult times. For Indians, gold has traditionally been the first investment choice, ahead of stocks, debt or real estate. While the yellow metal is no doubt a safe investment, a couple of points need to be noted.

First, returns on gold may not always be attractive. Take the case of 2011. Gold price, in dollar terms, appreciated by just about 11 per cent, though in rupee terms it returned 33 per cent. The higher returns in rupees was because of the depreciation of the currency vis-à-vis the dollar. Assuming that the rupee had remained stable or even appreciated versus the dollar, the returns picture might have been different.

The second point is about a more practical problem. While it is easy to buy gold, either as coins or as biscuits or bars from authorised banks, it is not so easy to sell the same. Banks do not buy back gold coins or biscuits even if they were the same pieces sold by them. While the option of going to your family jeweller is certainly there, he will again not give you money in return. You will have to buy jewellery of equivalent value from him and, again, he will not give you the prevailing market price for the gold that you sell to him. There will be a discount on the price; maybe it will be smaller if you are well known to him.

Liquidity, therefore, is an issue with investment in gold. The asset is one for long-term investment with an eye on your child's marriage or education. It is certainly not for rolling over short-term cash surpluses. If you still prefer gold for short-term investment, you could go for gold exchange traded funds (ETF) where you invest in paper based on gold. While you can benefit from appreciation in gold price, you are not required to purchase an equivalent quantity of gold. You can trade in gold ETFs just as you trade in company shares.

Real estate

This is the trickiest of all investment options but if you get it right it will offer returns incomparable to any other. If you are unfortunate enough to get it wrong, then it can boomerang badly too. Real estate is a long-term investment by its very nature and the initial investment is, often, on the higher side.

Real estate mutual funds have yet to take off in India due to several issues but when they eventually do, they will offer a good avenue for those interested in an exposure to this asset class. Real estate prices are inextricably linked to interest rates and the prevailing high interest rate regime has put this asset class in the pale. Yet, given the long-term economic growth potential of India, real estate can only appreciate.

Attractive options

As we start 2012, stocks and debt appear the most attractive of the investment options. Those of you who are risk-averse and don't mind relatively lower returns can opt for the many debt instruments that are now available. Remember, you need to lock into them the next few weeks when many bond offers open to get the best returns.

Stocks are for those who seek returns that beat inflation many times over and understand that the investment is risky per se. Given that the market is at a low now, you can start accumulating the right stocks with some advice from professional money managers. Always follow a systematic strategy of buying in small lots over a period of time which evens out price swings. Here's to happy investing in 2012.