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Blindly chasing returns can be injurious to your goals

Just like we learnt in school in our moral sciences class, chasing temptation usually has unwanted consequences. In investing, these consequences are potentially life altering and not in a good way.

Chasing returns is a big reason why many individuals get into equity, directly or via mutual funds. When one reads about some mutual funds having given a historical return of over 20%, and with some small-cap and mid-cap funds having given 30%-40% returns in some years, the temptation is understandable.

Just like we learnt in school in our moral sciences class, chasing temptation usually has unwanted consequences. In investing, these consequences are potentially life altering and not in a good way. Investors have learnt this the hard way, and if you meet an investor who has been around long enough, they are likely to have their own “chasing returns” story.

In this piece, our focus is on why chasing returns is not a great idea when investing for goals.

Returns are important but…

Here’s the thing about returns. An investor saving and investing for goals needs returns to make up for the fact that they can’t “save” the entire goal amount. Let’s say Ramesh is a 35-year-old software engineer saving up for a comfortable retirement. His financial advisor comes up with a plan that says that based on his current lifestyle and future needs, he would need about Rs 4 Cr to retire.

Ramesh is quite a practical individual and knows that while he can work hard and hope for the best, the probability of his reaching extremely high salary levels, are the same as most of his better peers. 

Everybody wants to become a CXO but not everybody can or will be. This means that Ramesh can’t simply expect to “save” up from his earnings. He muses that he might be able to save maybe half the retirement amount over two decades. But what about the remaining two crores?

That’s why he needs to invest in something that can literally double his savings. His advisor suggests equity as the most reasonable way to reach his retirement amount. Now, this is where the whole returns thing comes up. Returns, when you consider long periods of time, need to stay ahead of inflation for them to be considered worthwhile.

If an investment doesn’t generate inflation beating returns when investing for a long-term goal then that investment generally won’t make sense, at least for the long run. 

….Goals, and the time remaining, are more important

If an investment doesn’t generate inflation beating returns when investing for a long-term goal then that investment generally won’t make sense, at least for the long run. 

Imagine walking on a conveyor belt going the other way. The speed of the conveyor belt is inflation while your speed is what you can save. When you invest in inflation beating assets, it’s like wearing a jet pack that helps you counteract the force of inflation that is pushing you back.

The nearer the goal, the lower the returns you need, technically. This is because most of the goal amount will come from your savings rather than returns. Why can’t most of the goal amount come from returns, you ask? 

Simply because the higher potential returns involve high short-term volatility as well as potential investment risk of the instrument that you are hoping to get the returns from. 

What happens when you chase returns?

When you chase returns blindly, you are normally looking for the highest return giving investment. This normally means going for the highest return giving asset class and within it the highest return giving instrument. Certain small cap stocks and mutual funds have returned as high as 60% during freak years. The next year they went negative. 

To put it in simple terms, greater the return promised or expected, greater the chance that you could lose some or all of your investment. 

When you chase only returns, you are potentially compromising your goals by taking more risk than you might need to. There is no way to avoid risk but taking more of it than the goals, and timelines warrant is like trying to drive at 100 KMPH when your destination is just a few meters away.

Be smart, chase your goals, not returns.

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