The Signal: The right way to set performance expectations

India, in this millennium, has evolved into an Investment hotspot. India has been attracting attention from foreign and domestic players. Even in the face of the pandemic, domestic investors have continued to support Indian capital markets – the same is reflected in bellwether indices’ performance and record number of demat account opening in H1FY21.

As the world navigates through unprecedented times, India will develop faster and so will its markets and the participants. As participants mature through experience, they understand that investing is not about maximizing or minimizing but is, in fact, about optimizing and achieving expectations.

Setting the right expectations is an important aspect of a fulfilling investment journey.

It is easier to manage markets & money, than it is to manage investor expectations

(Almost Every Indian fund manager)

So now, what is a good way to have the right kind of expectations when it comes to investment returns?

While most are focused on “maximizing returns”, most cannot put a number to their expectation with a completely rational line of thought. 

Most people can be divided into a set of two based on their perception of returns in capital markets – 

1. First set – It is a get-rich-quick scheme where they can expect money to multiply overnight
2. Second set of folks believe that it is a speculative charade run by a manipulative set of people. They can never expect anything more than what they would playing a game of roulette.

Then there is a small segment of investors who understand the way markets function and know there is a rational way to base performance expectations upon – aiming to generate inflation-beating returns in the long term.

Take a moment. 

Money is nothing but a medium of purchasing power. With more money, you want to be able to purchase more and the bigger threats that can reduce the purchasing power of your money is inflation. So, in the longer term, you want to beat inflation to at least stay above water.

Time to take a closer look at the impact of inflation on money

Warren Buffet described Inflation best as, 

“gravity on asset values – The higher the rate, the greater the downward pull”. 

In layman terms, Inflation is the economic principle behind increasing product prices, and thus, reduced purchasing power. Remember when Onions went up to Rs. 120+/Kg or Zimbabwe currency was used as confetti? Now you know why.

As can be seen above, for any of your investment goals to materialize in the future your return on investment must outperform the rate of inflation.

Simply put, your money needs to grow at a rate faster than at which its purchasing power is reduced.

It has been empirically proven that, over a longer period, equities beat inflation in perhaps the most effective manner.

Do you disagree that inflation is perhaps the best metric to use as a base while deciding what expected return you should aim for? 

Write to us. We would be happy to hear your perspective on the topic. Also, if you present a solid case, there’s a real chance that we would be glad to feature your take on the topic in our next newsletter.