It’s often said too much of something is as
bad as too little of it. This idea applies to the returns on your investments
too.
Often clients invest their hard earned
money with the aim to maximize returns without taking undue risks. If an
investor expects to earn 15% or 20% CAGR from his/her equity investments over
the next 3-5 years, then he/she is expecting too much. This could leave his/her
financial planning in a mess.
It is, therefore, important to have
realistic expectations and be prepared for healthy surprises instead of a
shocker later on.
Market returns on equities over a span of
3-5 years are expected to fall short of historical averages.
WHAT’S A
REASONABLE RETURN AN INVESTOR CAN EXPECT ON EQUITY INVESTMENTS?
Corporate earnings, interest rates and
inflation, among other factors, change as economies expand and contract,
affecting the performance of the stock market.
The ability of equities to earn higher
returns comes from businesses’ ability to use borrowed funds, invest them in
assets, and earn returns that are higher.
In a theoretical environment, an equity
market return should be equal to nominal GDP growth plus 1-2% premium.
Growth in businesses is reflected in the
country’s GDP growth. So if India’s GDP is likely to grow at 5-6% and the
inflation is in the 4-5% range, then the country’s GDP in nominal terms may
grow at 9-11%.
Hence, in the Indian context, the average
long-term returns from equities have been about 15%. But future estimates are
10-12% (inclusive 1% Premium). This will come down if the inflation or GDP
growth falls in the future.
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SENSEX CALENDAR YEAR RETURN
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2023
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2022
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2020
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2021
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1984
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2019
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1985
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2013
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1989
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1991
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2018
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2010
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1992
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|
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2009
|
|
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1983
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2019
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1980
|
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2003
|
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1995
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1998
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1986
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2002
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1994
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1990
|
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2006
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1981
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2000
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2001
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2015
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1996
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1997
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2017
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1993
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2007
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1999
|
|
2008
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2011
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1987
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1982
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2016
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2004
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2012
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2014
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2005
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1988
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<-30%
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-0.5
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-0.3
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-0.1
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0-10%
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10%-20%
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20-30%
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30-40%
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40-50%
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>50%
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20 years Average return = 18.9%
10 years Average return = 13.2%
As you can see, in about three-fourth of
the years, the market is up and in about one-fourth of the time, it is down.
The distribution is roughly a bell curve with a positive skew and a fat left
tail.
The key to long-term success as an investor,
therefore, is to have realistic expectations and invest accordingly to achieve
your investment goals.