Recently, a customer wrote to us with a concern that we were showing an incorrect return figure on his ‘Short Term Money” investments. His portfolio return was close to 16% over a one-year period and he felt there was a mistake because debt fund returns are usually only 8%-9%.
As it happened, the high return was accurate and had been brought about by our recommended funds having taken advantage of interest rate movements in the last year.
My team was baffled that a customer was ‘complaining' about good returns but I was delighted. Here was a Scripbox member who truly understood investing.
Having a reasonable expectation of returns is the most important principle of successful investing. It helps you choose the right investment options and stay the course with your decisions.
The reasonable return on Equity Funds
Smart investors understand that equity fund returns over a long period average to 14%-16%. They don't expect to double their money in two years. They know that it takes time (5-10 years) for that return to be realized.
They understand that equity fund returns are not guaranteed. That there will be periods where your return would be negative, as well as periods where the return would be dramatically high. But this will average out over time, and that long-term average of inflation-beating 14%-16% return is their goal.
The reasonable return on Debt Funds
Smart investors, like the one who wrote to us, also know not to expect fantastic returns from debt funds. They also know that debt fund returns are not fixed. That even in debt funds you may have periods of low (even negative) and high returns.
While both kinds of funds have some amount of fluctuation, the frequency and scale of fluctuation is far lower in case of debt funds and averages out over a shorter period - a few months to a year - compared to equity funds where the fluctuations are larger and take much longer (5-10 years) to get to average.
Smart investors know that, for the reasons stated above, short term goals are best met with debt funds and long term ones with equity funds.
Smart investors don't try for exceptionally high returns in just a few years because they know that the effect of compounding doesn't kick in in less than 5 years. (See table below – difference in accumulated amount is very small for different rates of return in the short term)
Smart Investors allocate their money with a full understanding of the amount (percentage) and nature (fluctuation) of returns.