Understanding “Reasonable Returns” In Investing

Introduction

Most investments do not assure returns, as they are subject to various factors, such as economic or market conditions. On the other hand, investors often enter into investments with expectations of fabulous returns. Some even cannot come to terms with the fact that all investments do not give assured returns. Influenced by stories from dear ones about doubling their money within a couple of years or faster, new investors set foot in the market with high hopes. But unreasonable expectations lead to disappointment for everyone involved. In this article, let's look at how you can earn reasonable returns from your investments.

Setting the Expectations Right

Getting reasonable returns can be difficult since the actual performance of a product is not always aligned with its description. You must consider factors such as fluctuations in cost, inflation rate, and taxation level when anticipating the return of a product. When calculating the returns, consider the figure after expenses and taxes. If the post-tax return is greater than the average rate of inflation then it can be considered a good investment. You can expect reasonable returns based on other factors which contribute to improving results.  

All investment instruments are designed to contribute to the financial wellness of investors and help them achieve their goals. However, you must understand they have different investment terms. The complete potential of an instrument can be realised only if the investor adheres to the pre-requisites. To improve the returns from your portfolio, you must diversify it. Depending upon your financial goals, you must invest in either safer avenues such as EPF, PPF (Public Provident Fund), insurance policies, gold or real estate, or riskier ones such as equities, cryptocurrencies, hedge funds. Your investment will generate good or bad returns for achieving your goal based on how you build your portfolio. 

How to Calculate Return on Investment?

To achieve reasonable returns on your investments, you must first learn to calculate the returns your investment will generate. You can easily calculate your ROI using the following formula-

ROI = (Value at end of investment term  - Value at beginning of investment term) / Value at beginning of investment term

The result is the ratio or percentage of return your money will earn from the specified investment.

Suppose you invest Rs. 100,000 in the stock of a company at the beginning of a year. At the end of the year, if the stock price goes up and the value of your investment becomes Rs. 110,000. 

The ROI on this investment can be easily calculated as follows:

ROI = (Rs. 110,000 - Rs. 100,000) / Rs. 100,000 = 10%

Upon comparing it with the historical stock market returns, your investment has achieved a reasonable ROI. Similarly, before investing, you can calculate an approximate ROI percentage to predict the potential of your investment.

Reasonable Return on Equity Funds

With much awareness, smart investors now understand that equity funds generate an average of 10%-11% returns. It helps control unreasonable expectations such as doubling their money in two years. It is important to realise there will be periods when the returns from equity may be negative, as at other times they could be dramatically high. However, it would average out over time, but it is not guaranteed. The goal usually is to achieve the long-term historical average that is an inflation-beating rate of around 10%-11%.  

Reasonable Return on Debt Funds

Smart investors are aware that even debt funds are prone to some amount of risk. Fluctuations in interest rates impact returns on debt funds. The return from debt funds is not fixed and they might also experience periods of low or even negative returns. However, depending on the fund's performance, they may generate unexpectedly high returns as well. 

Debt funds are best for short-term goals, while equity is useful for achieving long-term financial plans. Rather than focusing on exceptionally high returns quickly, savvy investors aim for an average return. You must at least stay invested for 5 years to generate desirable returns. You must also understand that compounding can take up to five years or more before it starts working effectively in your favour. Thus, consider the time horizon of your investments as a crucial factor.

How to Generate Reasonable Returns on Your Investments?

Expecting reasonable returns from your investments is just the tip of the iceberg. You must invest smartly to generate returns that average out against market risks and inflation. Here are some pointers to keep in mind to generate reasonable returns from your investments-

1. Understand How Asset Classes Work

It is important to understand the basics of investment asset classes in order to make informed decisions. 

There are four types of asset classes: 

I. Equity

II. Debt/Fixed Income 

III.Gold

IV. Real Estate

Each asset class has specific features that you should consider when allocating your funds to it. There are specialised instruments under these classes designed to achieve specific goals, such as retirement. 

You should diversify your investment funds in each of these classes. So, to cover your risk, invest in debt funds (bonds and mutual funds) along with equity funds.

2. Have a Goal-based Financial Plan

A solid financial plan keeps you on track with your goals and supports optimal decision-making. Take into account cash flows, existing investments, taxes, and distribution planning along with risk profile to tailor your investments as per your needs. Having a financial goal also acts as a guidance system to help you navigate through obstacles, such as market volatility or behavioural biases like overconfidence. 

3. Take Professional Help

Financial planning needs expertise and with so many products in the market, picking the best one for your needs is no cakewalk. You are the best person to define your financial goals and the risk you are willing to take. But to allocate your funds to different investment avenues and make the most out of them, you must take professional help. 

The little investment you make on a good financial planner ensures you keep on track with achieving your financial goals and save yourself from a big loss. It is a great way to maintain your financial health while constantly earning reasonable returns. 

Conclusion

Good returns are not just about good numbers. It must be judged by the progress you are making towards achieving your financial goals. So make sure you define your short-term and long-term goals before looking for investment options. It will help you decide what suits your needs better. Past data and risk factors are reference points, but they do not assure returns, so expecting reasonable returns helps you invest wisely.

Summary

Investment instruments provide financial wellness, but you must understand their terms to avoid disappointment.

Returns are not guaranteed on any investment, rather can only be predicted. 

Investing is a long-term process and the results are influenced by economic and market conditions. It is thus advisable to set your expectations right and look forward to reasonable returns from your investments. 

The complete potential of an instrument cannot be realised without looking at its prerequisites and matching them with your financial needs. 

Depending upon your financial goals you can pick less risky avenues such as EPF, PPF, insurance policies, gold or real estate, or more risky options such as equities, cryptocurrencies, hedge funds. When contemplating an investment, the return must take into account changes in cost-of-living, inflation rates, and taxation levels.

To increase the return on your portfolio, you must diversify it and maintain a good balance between high and low-risk instruments. It is important to understand that the assessment of risk associated with an instrument depends upon the individual’s financial goals. 

You can consider past data and factors as reference points when calculating returns. But some ever-changing factors like market volatility and duration of an investment may have a different impact on the returns.

Key Takeaways

• Calculation of return from the investment must be done considering fluctuations in cost, inflation rate, and taxation level.
• A good understanding of asset classes allows you to diversify your funds.
• Goal-based financial planning also ensures you generate reasonable returns.
• Calculate an approximate ROI percentage to understand the potential of your instrument, before making an investment decision.