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Why Keeping Unrealistic Expectations From Investments Is Stupid! - Outside View by PersonalFN

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Why Keeping Unrealistic Expectations From Investments Is Stupid!
Jul 18, 2017

Children are often burdened with unrealistic academic expectations in their life. However, parents, teachers, and mentors must teach them that there is more to life beyond score-cards. All the toil is worthwhile only if they grow up becoming better human beings, who are kind hearted, empathetic, helpful towards the needy, etc.; because there's more to life than mere numbers. What matters is the journey and how qualitative that has been.

Similarly, when making investments, returns are not the only thing you should look at. Wishing for something big is good, but working towards a financial goal on the basis of unrealistic assumptions might lead you downhill.

Many mutual funds might have performed exceptionally well in the past; however, remember that their future performance is not dependent on their historic valour.

Consider these following points to get a holistic view about investing...

Risk-return trade off

There would have been times in past when you were lured by investment products offered by your relationship managers and investment agents simply by taking into consideration the rate of return offered. However, there are a host of other factors you as an investor need to assess. One of the most important factor, amongst all of these, is risk.

You see, everything comes at a price, including returns on your investments. To make higher gains, you need to have a considerable risk appetite. In other words, a high return generated on your investment is the premium you earn for bearing high risk. This is known as risk-return trade off. Almost all investment products are exposed to various risk, only the degree differs. Therefore understanding the risk-return trade-off of every asset class and investment avenue therein, to assess if it suits your risk profile is critical before you invest your hard earned money. It would be imprudent to go just by the returns.

Right asset allocation

Pay heed to your asset allocation. Based on age, income & expenses, assets & liabilities, risk appetite, investment objectives, investment horizon and financial goals; define your asset allocation.

Asset allocation refers to distributing your investible surplus across asset classes such as equity, debt, gold, real estate, or even holding cash for that matter. So, by allocating assets, you are essentially adopting an investment strategy that can balance your portfolio's risk and rewards keeping in mind your risk profile, financial goals, and investment time horizon.

As cited before, each asset carries with it a certain level of risk and expected return.

For example, within the debt / fixed income space, a Government bond would be low to no default risk, and hence low return, compared to say a corporate FD, which is not secured like in case of bank FDs (which have a Deposit Insurance and Credit Guarantee Corporation (DICGC) cover upto Rs 1 lakh for both principal and interest amount held in the bank). Hence, each of these investment avenues command a relative level of risk and return.

Not all assets will reward higher risk with equally higher returns. Those that do not offer enough expected returns for a high level of risk are considered 'inefficient'.

Investment time horizon

Asset Allocation varies with available time horizon before a financial goal befalls.

For somebody with a short-term investment horizon of less than 3 years, it is advisable to allocate towards fixed income securities, and refrain from allocating to asset classes such as equity and gold, owing to their variable returns, where the risk is elevated due to a shorter investment time horizon.

For a medium-term investment horizon, i.e. 3-5 years, you can allocate some portion of your investible surplus to equity and gold to take advantage of the higher risk-reward ratio that these classes offer, but not go gung-ho.

For a longer-term investment horizon, i.e. over 5 years, you can allocate a higher proportion of your funds to riskier asset classes to take advantage of the power of compounding in your longer time horizon. Having said that, maintain some exposure, if not too high, to fixed income and gold whereby the risk can be mitigated to an extent.

For an investor, it is vital to recognize the risk-return trade-off of any asset class and be realistic in expectation of returns and gauge the performance of their portfolio prudently.

'Time in the market', rather than "timing the market"

Everyone wishes to enter when markets are low, and exit when they are at the peak. However, it is impossible to accurately predict the market direction every time, irrespective of market analysis and research. Take 2009 for example, a large number of investors missed the reversal of stock markets and lost opportunities to buy when valuations were really cheap. On the other hand, in 2013 many retail investors exited from the markets when markets were languishing. They missed the upside thereafter when Modi-led-NDA came to power with a thumping majority.

PersonalFN is of the view that, you should focus on your long-term financial goals and aim to consistently invest in funds that optimise returns for the level of risk they expose you to. Achieving your life goals requires a disciplined approach to investing and perseverance to ignore market momentum. There's no point trading, as it can be hazardous for your wealth and health. Remember, a trader is good only until his last trade.

To Sum-up...

To achieve your financial goals, it is critically important to assess your risk appetite first.

Once you are sure about it, start investing in systematic manner. Plus, diversify your investments across the asset classes and monitor your portfolio once in six months.

Happy investing!

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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