A key assumption that you need to make while setting financial goals is the return from investments
. This is because unrealistic expectations can leave your finances in a mess. Let's assume you want to save Rs 10 lakh in the next 10 years and expect a 20% return on investment every year. On the basis of this assumption, you will have to invest Rs 2,615 every month for 10 years. Now, what happens if your portfolio returns just 12% a year? You will fall short of the target by Rs 4 lakh. Such a big deficit can leave you in the lurch.
It is, therefore, important to have realistic expectations and hope for pleasant surprises, rather than get a shock later.BALANCED VIEW
Expectations depend on the portfolio. As a general rule, the higher the risk, the higher is the expected return. So, equity is expected to yield more
than fixed-income securities and bank fixed deposits.
Real estate and gold have given double-digit returns over the last five years and attracted a lot of investors.
While making a financial plan, it is important to keep in mind that an asset's performance over the last four-five years cannot be expected to continue for a longer period of, say, 10-15 years. It's best to go by the asset's long-term performance.Equity:
The National Stock Exchange Nifty has given an average annual return of 12.5% in the past 15 years. This is tax-free and five percentage points more than the average inflation of 7% during the period. If we consider the 10-year return on every trading day since December 2007, the Nifty has risen 16% a year. This shows that though there have been periods when equity has returned 20% or more, you should expect just 12-15% a year over long periods.
"Our research has shown that with an investment horizon of seven years, there is a 74% probability of earning more than 12% and 64% probability of earning more than 15% a year," says Sanjiv Singhal, chief operating officer of scripbox.com, an online platform that facilitates investments into select equity mutual funds.
"Discipline and patience are the two hallmarks of a successful equity investment. There are prolonged periods of practically no return and then in a short period the entire appreciation get bundled together," says Sunil Shah, head of equity research, Axis Securities.Gold:
This alltime favourite investment has given over 25% a year in the past five years, leading to high expectations.
However, in the past 20 years, the returns have been 10% a year. The figure for the past 15 years is 12%. Experts say gold should be used more as a tool to hedge and diversify the portfolio than to earn very high returns.
"This may not be palatable to many, but it is true that returns from gold are secondary. The metal's main purpose is to hedge against crash in prices of other asset classes," says Lakshmi Iyer, head, fixed income and products, Kotak Mutual Fund.
"It has low correlation with other assets in good times and negative correlation in extremely bad times. Therefore, it is a good tool to balance the portfolio. It is also the least volatile. Therefore, investors should not see it just as an asset that offers high returns," says Amresh Acharya, director, investment, World Gold Council.
Returns from gold are secondary. The metal's main purpose is to hedge against crash in prices of other asset classes: Lakshmi Iyer
Lakshmi Iyer of Kotak Mutual Fund says gold can give 10-12% a year in the next couple of years before a lull in 2015.Fixed income options:
Government and corporate bonds have given good returns over the last couple of years with 10-year government bond yields touching 8.5-9%. Debt mutual funds, especially income funds, have been generating 9-11% a year. Banks have been offering 9-10% on fixed deposits while corporate fixed deposits and non-convertible debentures have been giving as much as 12.5% a year.
However, with the Reserve Bank of India expected to cut rates in the next few months, the returns from fixed income options will no longer be this good.
Iyer of Kotak expects a 0.5-1 percentage point fall in returns from debt in 2013.
So, if your portfolio is debtheavy and you are thinking about doubling your money in five-six years, you better wake up to reality. You can expect 5-7% posttax returns from debt in the long run.Real estate:
Most people have sky-high expectations from this asset class. For example, prices in some areas of the Delhi National Capital Region have risen 600% in the last seven years, which comes to a 32% annual return on investment.
Is it sensible to expect such high returns over long periods? "No asset can offer such returns on a continuous basis, and like other assets, real estate could see a price correction," says Jitendra Solanki, a Ghaziabadbased certified financial planner whose many clients have redeemed stocks and mutual funds to invest in real estate.
Anshuman Magazine, chairman and managing director, CBRE South Asia, says, "Real estate prices depend on various factors. These include demand and supply and the scenario in the financial markets. Real estate should not be considered a short-term investment. One must invest for long periods to make decent gains."
"The average return in metro cities in the next 5-10 years will be 10-16% a year. However, there will be pockets which will give 20% a year over five years," says Rajiv Bajaj, vice chairman and managing director, Bajaj Capital.DISAPPOINTMENT & DISARRAY
One reason for unrealistic expectations is investors' tendency to look at just the top performers (best performing funds, stocks, etc).
However, studies show that returns from an asset class converge towards the long-term average. If the long-term stock market return is 12%, it is better to go with that than take very high short-term return as the norm.
Often, high expectations leave investors disappointed. As a result, they may be alienated from an asset forever, which can damage the overall portfolio.
For example, many investors who entered the equity market in 2007 or early 2008 expecting the spectacular returns of the previous four years are still scared of investing in shares after burning their fingers in the 2008-09 crash Now, most of them have debtheavy portfolios, which barely give them inflation-beating returns, or invest in real estate, which is highly illiquid and risky.
Very often, such investors, in hunt for hyper returns, fall prey to chit funds and Ponzi schemes.MAGIC OF COMPOUNDING
Investors often do not realise that they can create a good corpus with 10-12% annual returns.
"We have shown our clients how they can achieve their goals even with a 10-12% return. All they need is a little patience," says Solanki.
Compounding can throw up pleasant surprises. A monthly investment of Rs 3,000 for 30 years will grow to more than Rs 1 crore if the annual return is 12% (See Powe of Compounding). "People get nervous when a retirement calculator throws up a figure in crores. But they don't realise that their provident fund money that has grown at 8% or more over the years will itself be quite big over a period," says Nitin Vyakaranam, CEO, Artha Yantra, a financial planner.
The key to the long-term success, therefore, is to have realistic expectations and patience to allow investments to grow in a disciplined manner.