Those of us who invest, usually have growth on our minds. But why do we want our money to grow? The most obvious answer that jumps out is that what you invest should become “more”.
It’s not just the “more” we are seeking, we want this growth as quickly as we believe is good. This is where returns come in. Higher the returns on an investment, the faster your money grows. We feel quite happy when we see our equity investments give double digits in a year. The next year we feel outraged when we see returns in the negative. This see-saw makes us question how to even look at returns.
We believe you need to know before you invest why exactly do you need the returns. The answer to this question will decide what to invest in and your baseline return expectation from that investment.
Why you and I need returns?
Simply put, the primary reason why you need returns is to make sure what you save doesn’t lose its value. It should also grow at a rate that is greater than, or at least equal to, inflation.
In the short term (less than 5 years), the growth of our money is generally a function of our salary or income growth which in turn depends on other factors. Some of these are under our control and some not. You definitely have greater control over these “returns” than any financial market will provide.
In the long term though (10 years or more), your savings are impacted the most by inflation. To guard against that you need to put your money, and faith, in something that has a chance to beat inflation.
That something is the Indian economy in this case. One thing is for certain. Despite whatever is happening right now, the economy and the companies in it have the best chance of growing fast enough to beat the increase in prices of commodities. History shows that.
That something is the Indian economy in this case. One thing is for certain. Despite whatever is happening right now, the economy and the companies in it have the best chance of growing fast enough to beat the increase in prices of commodities. History shows that.
The Sensex (which is a good proxy for Indian companies) has grown by a CAGR of roughly 12%-13% over the past 19 years. Inflation (CPI) on the other hand has been 5% or lower in the recent past.
In the past two decades inflation in India has varied but rarely crossed the 15% mark (the highest). Considering long term inflation has been in the 7%-8% range, equity returns, as measured by the Sensex, have beaten inflation by a sufficient margin.
Since most fixed income instruments depend on the interest rates decided by factors governed by the Central Bank (RBI), the returns for FDs and other debt instruments tend to be one or two percentage points above inflation and track it. Considering how interest income is taxed, you often end up earning less than inflation. The chart below shows how liquid funds have done versus inflation to give you an idea of what FDs (pre-tax) and the like would have achieved.
