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When can you afford “high returns” from your investments?

In investing, your “speed” and where you are heading matters, and so does the road.

Have you gone on a road trip recently? Those of you who have might have noticed that sometimes the road you have taken can become rough without warning and the sudden bumps make you slow down immediately. You tend to be more careful about your driving speed then. No matter how great a driver you are, rough roads are best handled with deliberate care.

Something like this happens when investing. In investing, your “speed” and where you are heading matters, and so does the road.

Where you are heading

Smart investors generally have a goal in mind as this makes sure their investment behaviour and the choices, tend to be tailored to that goal. This, in turn, lowers the probability that they will produce “avoidable” mistakes such as not giving their investments enough time. 

The road

In the context of investing, the pathway you take towards your goals means staying invested in the right asset classes that are relevant to those goals. It also means shifting asset classes when you reach near your goals. This brings us to “speed”.

Returns need to be aligned with goals. When your goals are far away, you can actually afford the volatility because what should matter to you is the long-term return over many years rather than just the annual rate of return in that year.

Speed

Speed implies returns, in the context of investing, that an asset class delivers. Unlike driving, in investing, you don’t really have control over returns. The only way you can control this is through asset classes. 

If you want higher returns over a more extended period which beats inflation you choose equity and if you intend to go slow but sure and simply match inflation, when your goal is nearer, then you should choose fixed income.

This matters a lot because you should understand how much “returns” can you afford depending on where you are vis-à-vis your goals. Always remember that higher the returns, higher will be the short-term volatility or even potential loss. When driving fast, you tend to feel the bumps more than when driving slowly.

Returns need to be aligned with goals. When your goals are far away, you can actually afford the volatility because what should matter to you is the long-term return over many years rather than just the annual rate of return in that year. 

On the other hand, when you are nearing your goals, you really can’t afford the volatility that comes with choosing higher return and inflation-beating asset classes like equity. 

Smart investors don’t automatically assume that higher returns are always a good thing. There is no point in earning very high profits for one year and losing it all the next. What matters is whether the returns you made consistently are enough to get you to your goals. 

The next time you look at returns, check whether the asset class that they belong to are appropriate for you, depending on your goals. 

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