About two years ago, a bank relationship manager pitched me an investment in a complex investment product. I informed him that I was not interested but he insisted that I should still consider it.
Sitting at my desk, sipping chai, I listened to this well-dressed man in a suit talk about how there was no better avenue to invest. He promised me fifteen to twenty per cent returns minimum from this debt product. I heard him out, but all I could do was wonder about how, in a time when fixed deposits were giving low single digit returns, this man could promise such high performance with utmost confidence.
In investing it is very important to keep realistic expectations of your returns. What are good benchmarks to look at when you are trying to evaluate a product?
The returns of debt funds and fixed income are anchored by inflation and interest rates. Just after the 2008 financial crisis we used to have interest rates that were in double digits and so it was reasonable to expect returns in-line with that. Today the RBI targets inflation to be roughly in the range of two to six per cent. And therefore, if you are trying to achieve returns that are much higher than that, it means that there is additional risk that you need to be cautious of.
In a previous post, we talked about how buying equities was a bet on entrepreneurship. It is a bet that the hungry entrepreneur will use all her creativity and hard work to grow her business at least as much as everyone else in the economy. The best proxy for this is to look at the growth rate including inflation. For the last two decades our nominal GDP was in the double digits and this has unfortunately anchored our expectation for equity returns to be fifteen, eighteen and maybe even twenty per cent. The reality though is that today we are in a different era, inflation has come down and so has the growth rate. Therefore, we have to adjust our equity return expectations down as well.
If we expect returns that are much higher than the benchmark, then we might be setting ourselves for disappointment. Having the right expectations can help us to plan better to meet our financial goals.