Most people invest for getting great returns and some try to get that thorough insurance policies. People ask me which stocks will rise in the next week, which mutual fund scheme is providing the highest return etc.? Is it time now to invest in Gold or whether the stock market will move up or down? Are there any schemes which double our money in the next two-three years, etc., etc?
Ask yourself what is the fundamental requirement – getting returns now or making investments for your life & goals ahead. The sole objective or goal in life cannot be just making lots of money; it should actually be meeting one’s goals on time.
If that is the case, the right question to ask yourself is “What is my required rate of return & where do I invest, which will help me achieve my financial goals easily and comfortably?”
What are your Goals?
Do all of us have some financial goals? Yes, we all do. These may include buying a nice house, second house, car or big car, going on vacation or world tour, getting a better regular income, funding your children’s education, a retirement free from money-related worries, etc. What do you think would happen if someone comes to you and tells you that all your financial goals in life will be met with a 100% guarantee, irrespective of how much you earn, no matter what happens.
Then do you think you would still carry on with your investments? Would you still worry about buying the best mutual fund and not the 3rd best one? Would you still shift your investment to a new financial product for the extra 1% return?
No, you wouldn’t. I am sure that you would then concentrate on how to achieve your goals faster rather than on how much returns, product names, fancy strategies… You would start thinking at a different level and that would result in a simple financial life! Your only concern would be how to achieve your financial goals fast and as easily as possible.
Now, the question that crops up is what rate of return I require to achieve my financial goals. Am I using the right word “rate of return” to reach my target amount? Surely not! Rate of return means we are talking about just nominal return as we don’t consider the effect of inflation. For example the 9% earned in a bank fixed deposit is nominal return. But this is not the correct way of measuring return. The return calculated after considering the effect of inflation is the right way to measure the return and is known as the real return.
Real rate of Return
Let’s understand “Real rate of return” assuming your investment has made return of 8% (nominal return) and the average inflation that year was 10%, the real return is a negative 1.81%. Which means actually on maturity you did not make any money; in fact your money has lost value due to inflation. Inflation is a silent monster and it erodes the value of your money if you don’t invest wisely. So consider the effect of inflation while measuring your returns on maturity.
Setting of Returns on your investment
Setting of returns involves careful study of few factors:
- What is the present value of goal?
- What is the time-horizon of goal?
- What will be inflation factor over the years?
- What should be the periodic investment towards the goal?
- What product mix we have to take?
- What risk is involved in return?
Once you are clear about your goals, you start investing towards them and get set rate of return on your investment and you realize that your financial life is unique; you stop comparing it with that of others.
Imagine This: You start investing Rs. 5,000 per month towards your child’s education. You have been advised that if you make 10% year on year, in 20 years you will reach the target of approximately Rs. 50 lakh. Now suppose in a particular year, your mutual fund gave a 21% return, but your friend’s mutual funds gave 34% return. This will definitely make you think that your fund performed poorly compared to that your friend. But you know that you are still on your path and have outperformed your own benchmarks. You have made better progress than expected. On the other hand, if your funds gave a 5% return and your friend’s mutual fund gave a negative 10% return, you might be a bit relaxed and happy about the fact that at least your mutual funds performed better than his. But the next moment you will come back to your own financial life and feel that whatever the case, you have underperformed your target of 10% each year.
In both cases, it will be about YOU and YOUR GOALS first and only then will you see it in perspective. If you don’t have any goals and targets, the only benchmark you have is comparison with others. Then you start looking at your friend’s return, the best funds in India and the average in the category in which you have started. While all that is fine and required, to some extent, the only point I want to make is that after setting goals and linking your investment to them, your financial life becomes simpler and you have less things to worry about than getting higher return.
In the above example, the per-year-comparison was just for illustration. You should not be worried just because your mutual funds didn’t perform well during one particular year. You would be better off considering the returns over a longer time span. In our example, you could check if your funds have given 10% yearly return for a 3-4 year time frame before you get judgmental. Always look at the performance over the long-term and conjunction with your goals.
Right message in the right time.