Can I expect a 25% return from equity?
Queries along these lines are so common. So I am going to address the underlying issue here. To do so, I borrow heavily from the insights of Dan Kemp, Morningstar Investment Management’s Global CIO.
- It is good to be optimistic.
Every time we purchase an asset, we express confidence in the future: that companies will grow their profits, borrowers will repay their debts and governments will allow capital to move freely around the world. Investing is an exercise in optimism. Without optimism, there could be no capital markets, no entrepreneurship and ultimately no human development. But, there is a need for realistic optimism.
- Be cautious about your optimism.
Too much optimism can be dangerous for investors, as it can alter our behaviour leading us to take too much risk. If empirical evidence is our guide, there is an enormous gap between investor expectations and historical norms. Let's just take a quick look at the annualised returns as on September 1, 2022.
Nifty 50 TRI: 13.38% (5 years), 13.73% (7 years) and 14.21% (10 years).
Nifty Next 50 TRI: 10.22% (5 years), 13.40%(7 years) and 17.42% (10 years).
- Be aware of being swayed by sentiment.
When thinking about returns, investors tend to suffer from ‘base rate neglect’. They ignore long-term data – the base rate – when making forecasts, in favour of a more recent experience or an appealing narrative.
One of the reasons expectations stray so far from reasonable expectations is that investors tend to be conditioned by recent experience – despite the fact that the starting position is very different.
This is something that investors forget. The ability of an investor to take risk does not change, but the investor’s perception of risk does. In bull markets, many turn aggressive and in bear markets they turn extra-cautious or ultra-conservative. Such a view of the market returns has nothing to do with the future. It is just the future projection of the current sentiment.
If you have very high return expectations, it could lead to these dangers:
- You will save too little as you expect your invested capital to make an unrealistically large contribution.
- Unrealistic expected returns may discourage you from making additional investments or may even lead to you selling those they already have. In doing so, you destroy the benefit of long-term compound returns that lies at the heart of every successful investment strategy.
- Consequently, you may not have the required amount to meet your financial goals.
- If you find yourself falling short, you may be tempted to increase the amount of risk just to get a higher return. And by investing in risky assets, you put your portfolio in danger.
You invest to achieve certain financial goals. If you base your planning on stretched expectations, especially during the bullish times, your entire plan could backfire lowering the probability of achieving your goals.
Please moderate your return expectations, and increase the amount you save and consequently invest.
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Articles authored by Investment Specialist Larissa Fernand
Registered readers can post their queries by accessing the Ask Morningstar tab. Our team will answer SELECT queries relating to mutual funds, portfolio planning and personal finance. While we provide broad guidelines, we suggest you consult a financial adviser before making investment decisions.
