“The markets have done so well over the past few months, but I do not see much gain in my portfolio.”
I hear this sometimes from new (and impatient) investors. Despite investing in the markets, they feel they have been left out of the market rally.
But why would that happen?
Well, this could be a result of betting on the wrong horse, but I am not talking about such cases. You have been investing in a good product that has offered good returns in the recent past, but you are still dissatisfied.
Because you can’t eat percentage returns (CAGR or XIRR). You can only use absolute returns. The growth in your portfolio in rupee terms. If your portfolio is small, then the returns on the portfolio cannot be big (unless you take a big risk, and it pays off).
20% return on Rs 2 lacs is Rs 40,000.
20% return on Rs 2 crores is Rs 40 lacs.
Does that mean you must invest big amounts to feel content about your investments? To create a big portfolio. Not necessarily.
That’s where compounding comes to your rescue. By investing small amounts consistently, you can accumulate a big corpus. It is simple math, but we don’t relate to it as easily. Our brains are not wired to appreciate compounding.
Let’s say you invest Rs 20K per month. And there is an investment product that gives you 10% p.a. Post cost and taxes. Consistently. Year after year. I know that’s not how things work in real life but play along. It is easy to drive home the point with these simple assumptions.
As you can see, getting to the first crore in assets takes a long time. 17 years. Subsequent crores come much quicker. You reach 2 crores in 23 years (6 years after you hit Rs 1 crore). Rs 3 crores in 27 crores. And so on. All this by investing Rs 20,000 per month.
Moreover, in the initial years, the bulk of the portfolio growth comes in the form of fresh investments. Around the 8th year, the portfolio returns take the lead and the impact of the fresh investments becomes less and less significant thereafter. Around the 20th year mark, the returns are contributing to 85% of the portfolio growth.
Coming back to the original question, during the initial part of your investment journey, you have much lower amounts invested. Hence, the absolute returns you earn on the corpus are also low, irrespective of the percentage returns earned. Hence, if you are looking for quick and large rupee returns, you are likely to be a disappointed. Either give yourself more time (to let your portfolio grow) OR you decide to invest big amounts to begin with.
While the decision to invest big amounts initially is not objectively unwise, such a decision takes you to a tricky terrain of “What-ifs”. As a new investor (with no experience of volatility), what if you make big losses initially? Would such an experience scar you or do you have the fortitude to ride over the short-term volatility?
Point to Note: Past seems pleasant in retrospect. Even big falls seem minor blips over the long-term. However, for investors who are experiencing adverse market conditions in real time, it is not easy. There is no guarantee that the future returns will be as good as the past returns. And investors know that. Hence, adverse market conditions can create confusion and compromise investment discipline.
Since, we are on this topic of rupee (and not percentage gains), I want to discuss two more aspects.
Fear of losses makes you invest too slowly.
Fear of missing out (FOMO) makes you invest too fast.
Fear of losses makes you invest too slowly
You can invest Rs 1 lac per month. You know a little bit about markets, and you are aware of potential of high returns. You are aware of the potential downside risks too. You start an SIP of Rs 5,000 per month in equity funds. You have ticked a check box. But are you investing enough? Clearly not. Even if this 5% (5,000 out of Rs 1 lacs) earns high return, the remaining 95% will easily drag down the overall performance. I covered this aspect in great detail in this post (You can’t eat CAGR or XIRR). The size of the bet (the investment amount) matters too.
Do note starting small is not a bad approach per se. It is a fine approach. Helps you understand the nature of markets despite not putting too much at risk. However, your position size should not always remain small. You must have some basis to make your position meaningful. An asset allocation approach is an excellent way to set milestones for your portfolio.
So, you start small. But you set targets. Reach 10% in risky assets (say equity funds) by the end of second year. 20% by the end of 4th year. 30% by the end of the 6th year and so on. And you take steps so that you hit those targets.
This way, despite starting small, you have a plan to make your risky investment position meaningful for you.
Fear of missing out (FOMO) makes you invest too fast
Now, let’s take it to an opposite extreme, where you throw caution to the wind.
You hear about an investment opportunity, and you sense a chance to earn quick returns. With such opportunities, there is always this sense you will miss out if you don’t invest soon. Happens with almost everyone, including me. Greed is human nature. Traditional and social media also add fuel to the fire.
Fair enough.
You have Rs 2 lacs spare cash with you. However, even if this investment were to double, you would earn only Rs 2 lacs. If your net worth is Rs 2 crores, the absolute return is only 1% of your net worth. Doesn’t sound exciting to you.
So, what do you do?
You bet more.
Instead of investing Rs 2 lacs, you decide to invest Rs 40 lacs (20% of your net worth). At one go.
While this investment may turn out to be hugely profitable, this is not a good approach to investments.
And such is the human nature that the same investor can display the different kind of attitude towards different investments. He/she would hesitate to put more than Rs 5K per month in equity funds but won’t bat an eyelid to put Rs 40 lacs in some much riskier investment.
In these cases too, taking an asset allocation approach can prevent you from you from taking an outsized risky bet.
Disclaimer:Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investment in securities market is subject to market risks. Read all the related documents carefully before investing.
This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in.Hence, you must NOT base your investment decisions based on my writings.There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa.Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investingin any investment productorfollowing an investment approach.
Featured Image Credit:Unsplash
