We as investors are mostly interested to know what returns I am going to get from my investments. It is seldom asked what is the real rate of return I am going to get.

It is very important to understand the real rate of return that is expected to come from one's investment rather than the absolute return which generally an investor ask for. To understand what you actually mean by the real rate of return and how it really helps in Wealth Creation you need to spare a few minutes to read through the article.

What is Real Rate of Return?

In simple terms, it is the return you earn above the inflation rate – which is the rate at which the prices, in general, are rising. To exemplify, if you invest in a fixed deposit which is today giving you a return of say 8% and the inflation is 6% then the real rate of return that you are generating would be 2%, ie., actual return (less) inflation for the period. The logic is simple – Rs.100 one or say 10 years ago does not carry the same value today because things have become costly due to inflation. Generally, consumer price Index growth (CPI) or wholesale price index growth (WPI) is taken as inflation indicators.

Having understood whats the real rate of return is, the question is how it is related to wealth creation. Let's understand what actually wealth creation means. Putting jargons aside wealth creation in simple terms is the increase in one's ability to purchase more things. If one feels his ability to purchase things have increased substantially over a period of time, one can simply say he has created wealth.

How can one increase its ability to purchase more through prudently investing?

That's a very right question to be answered. Let's go back to our example of one investing into fixed deposit with 8% absolute return and 2% real rate of Return. Say the investor had Rs 1,000 to invest in a fixed deposit. At 8% of interest rate, the value after one year of the amount invested would be Rs.1,080. Now assume that with Rs.1,000 he could have bought 50 packets of milk priced at Rs.20. Now with 6% inflation (assumed price increase of milk), the price of milk packet would be Rs 21.3 after one year.

At Rs 1080 available with the investor from his investment he now would be able to buy 51 packets of milk. The purchasing power of the investor has increased by one packet of milk thanks to the positive real rate of return. Had his return on investment been equal to the inflation he would still be able to buy only 50 packets of milk. And had his investment return lesser than the inflation, negative real rate, his capacity to buy milk packets would get reduced. That is the explanation why for creating wealth it is important to look at the real rate of returns and not the absolute returns on your investment.

Now interestingly let us look at the table below highlighting the approximate real rate of return across different asset class in India from 1981 – 2019. The question to ask is how it has increased the purchasing power similar to our example above over the period?

(Source: NJ Wealth – Internal. Assuming average inflation during period @ 6%.)

The results mesmerize us as to how the real rate of returns in equities over the period has increased the purchasing power and hence created wealth.

Never in the period considered had equities ever had a linear growth. There were many periods or phases when everyone considered to be the worst time for equity investors. For example, the equity markets in India post Harshad Mehta Scam (1994- 98) or post the Y2K technology bubble (1999-2001) or the after the Lehman brothers (2008-2012) and many such periods of dullness. But over the longer period, equities still delivered a real rate of return which increased the purchasing power the most as illustrated in the table.

Does the real rate of return increase the purchasing power over the shorter period say 5 Years?

The answer is NO. For a change in purchasing power, we require both time and returns.

What if we assume the same returns for the investor as return generated over 38 years to be generated in 5 years and measure the impact on the purchasing power?

There will be very marginal difference in the results and one cannot distinguish one from the other. Also, since equities are volatile in short-term, we cannot expect the same results of long term in the short term. That is not the nature of equities and something that everyone should understand.

Conclusion:

Equities change the purchasing power to a great extent and it been the biggest wealth creator across all asset class over a longer period, 10 years at least but longer the better, with the short term volatility. I would never understand why investor invests in equities and start seeing returns on a day to day basis and gets disturbed with short term negative returns. It is important to have a firm long term belief and give time to your equity investments for Real Wealth Creation through Real Rate of Returns from Equity Investments.

• Why are my returns low?

• Should I continue investing in current markets?

• What should I do to get higher returns?

These are some of the most common questions that we hear on the streets whenever the markets take a dip. Many investors who are new to the game are not really sure what is happening to the markets and to their investments. Are you having these questions? Have you been asked these questions? If yes, please read on...

What do I need to know?

Take a pause, clear your mind and go back to understanding the nature of the markets and the basic tenants of investing.

1. It is the nature of equities: So what makes equity exciting and rewarding as compared to a bank FD? It's because it is volatile in the short run with the potential to deliver superior returns in the long run. That is the basic nature of equities. It carries a risk which is not there in guaranteed investments. If you thought that equities deliver returns in a straight line, you are sadly mistaken. If you are investing in equities, you have to be mentally and financially prepared to take hits on your portfolio and digest even negative returns in short to medium term. If you cannot, I am sorry that you made a mistake of investing in equities. Please go back to guaranteed investments.

2. Why volatility is your friend: So it is clear that volatility is inherent in the markets due to many reasons. And it is because of this volatility that investors get opportunities to enter the markets, build on your portfolio and make strategic investment decisions (we will talk about it later). Without volatility, all the stocks will be fully valued to their (earnings) growth expectations at all times. In such a hypothetic and predictable market, everyone will invest in stocks and the advantage of equities over debt investments will no longer exist. It is only volatility that gives opportunities to investors and fund managers (mutual funds!!) to identify opportunities in the market to deliver 'alpha returns'. Alpha returns are the extra returns generated due to fund management expertise over and above market /benchmark returns.

3. Market timing is futile: Many studies have shown that equity market returns over the long term are fairly insulated from the short-term market volatility. In other words, your returns over say 10-15 years do not matter much whether you invest at Sensex 37,000 or 39,000. What would matter most is how long have you stayed investments. This is a fact and you can very well put your excel skills to good use finding out the extra returns you will get. In the end, the extra returns from market timing fall awfully short of the efforts, mental pressure and repeated transaction costs it carries. And this is only assuming that you are an excellent fortune teller who can predict how the markets will move. If you believe you can do that consistently over several years, you would be the first person in the world to do so and should be awarded a noble prize. No joking.

4. Asset Allocation strategy helps: So what should we do? Always remember that in investments, as in life too, often the simplest answer is the right answer. It is always the right time to go back to the basic tenant of investing – asset allocation. Yes. It is the time when you should do a proper relook at your asset allocation. It may be possible that your equity portion has reduced in size against your target. So realignment by moving some surplus funds from debt assets to equity to get back to the targeted asset allocation is what you can do. No rocket science here.

5. Investing in bear markets helps: Didn't we earlier say that falling markets provide an opportunity for investors to enter markets or invest more? Well, if you are a SIP investor, the news gets even better. All your SIP instalments being made in bear markets are surely getting you the much-desired boost to your portfolio. So do NOT stop your SIPs just because they may be delivering lower returns for now. Have patience and you will be suitably rewarded. Warren Buffet, the great investor once said that he will have absolutely no problems if the markets closed down for the next 10 years since his investment horizon is beyond 10 years. Take some time to ponder on this great idea.

6. Think discounts: Are you not excited every time Amazon or Flipkart offers great discounts? Don't you often end up buying new things which you do not even need just to benefit from these discounts? So why then do you think differently when it comes to dips in the market? Why can't you see that these are like discounts offered in the equity markets from time to time? Care to invest more now?

7. Losses are notional unless you make them real: Lets' get a bit philosophical here. No one can hurt you unless you allow them to hurt you. It's all how you think and feel from within that dictates your level of happiness and peace in life. The same philosophy holds very true for your investments as well. Your losses are notional and temporary. If you give them adequate time, they will recover and deliver decent returns over time. The market history tells us that the possibility of you generating negative returns from equity markets over say 10 years and above is almost nil, irrespective of all ups and downs during the journey. So just chill. Unless of course, you want to kick the axe yourself and enjoy losses by selling in panic.

Let us again reiterate some facts. Equities are risky in the short-term. They hold the promise of good real returns (above inflation and post-tax), more than any asset class in long-run. Short term volatility offers opportunities and is not necessarily bad. Stick to the basic idea of discipline, asset allocation, regular investing and time in the markets to enjoy better returns in the long run. Do not stop SIPs rather see if you can increase them. In case you still need help, just call your advisor for more gyan and assurance on the subject.

1. When Buying Insurance, focus on sum assured
Don't fall for policies giving you 10 times insurance cover. They are all expensive investment products in the garb of insurance. Check the Sum Assured Amount whenever you buy a policy. Prefer a term plan in Insurance. The approx cost of 1 Cr term plan for 30 year old is approx Rs. 7000 only.

2. Increase your sum assured
Increase your insurance coverage. Ideally your insurance amount should be Equal to 10 times of your annual income. Calculate your total sum assured from all your current policies and buy the difference amount before your birthday this year (it will save you some cost). Buy a term plan.

3. Pay a fee to get good advice, be it for taxes, insurance or investments
Nothing comes for free in the world. A good advisor knows his job and financial products better than you. Pay fee to get good advice, though it might pinch you now, but it will be definitely much cheaper in the long run. When you pay a fee for a good doctor, a good interior designer or a good lawyer simply to get best service and right advice, apply the same logic to your financial transactions too.

4. Mediclaim – increase your cover by 10% every year
Many of us are still stuck with old health insurance policies where we haven't increased the cover for many years. Go for minimum health insurance coverage of Rs. 10 Lac, ensure all your family members are covered (cost is going to be highest for your old parents, but that's where the chances of claims are also high). Think of your premium as 10 year investment. Even if you have to go through one big medical emergency in next 10 years, god forbid, it will still be worth it.

5. Check your nomination in investments and insurance
Do you know, post your death what will happen to your bank accounts, investments, who will get the insurance amount ?? If you have not filled up a simple nomination form, your family will be running from pillar to post to get the paper work completed just to prove that they are your legal heirs. To avoid all the hassles, just ensure that all your bank accounts, investments, bank deposits, insurance etc have proper nomination done.

6. Pay Credit Card bills on time
Never delay your Credit Card Payments. Never withdraw cash from your credit cards. You are charged upto 3.5% interest per month on it, which 42% annual rate of interest. If you are short of money or need funds for short term, better to go for Loan Against Securities (against your MF/Shares) which is available at 11-12% interest or go for personal loan at 14-15%.

7. Restart your SIP closed last year
If you had closed your SIP last year fearing market volatility or by looking into negative returns, time to restart it again. If possible, try to invest the amount of missed instalments together. Market down turns are the best times for SIP's to accumulate units. Do your SIP for 10-15 years, invest in it and forget it.

8. Increase your SIP
With your next salary hike, increase your SIP amount. Larger the SIP investments now, higher will be the wealth created in future. Higher SIP amount brings you closer to your goals. Make it a habit of increasing SIP amount every year.

9. Don't check your MF portfolio daily
If you have invested for long term, there is no point in checking your portfolio daily. All the gains/losses which you see daily are on paper. They will turn real only when you exit your investments. If your time horizon is for 5-10-15 years, what's the value of your portfolio in 2020 or in 2021 really doesn't matter.

10. Write down all your investment details at one place. Share with your spouse.
You might have different investments done though different advisors, or some insurance policies bought through banks, some tax saving investments made many years back or 5 different bank accounts. Write it all down at one place with bank a/c number, policy number, folio number, investment amount and all other relevant details. Put name of contact person for each investment. Just think of a scenario, that if something happens to you, ypur family won't even be aware how much money they are going to get.

11. Make your will
Just take a plain paper. Write down details of all your assets and liabilities and share a copy of that with your spouse or any other trusted family member/friend. WILL is not something which we make only when we grow old. Remember, all of us know our birth date, but none knows their death date. A WILL will ensure your assets are distributed to your family members in the way you wish with minimum fuss during legal procedures.

12. Stop worrying about your MF returns
Your Mutual Funds are giving low returns?? you are worried, want to switch your investments ?? A simple way to get over this is stop worrying. Let the investments be. Equity Mutual Funds, deliver superior returns over long term periods of 10-15 years. Just stay invested and keep patience. Chopping and churning will only dilute your returns and you might lose the opportunity when markets jump back.

13. Make your Financial Plan
Sit with your advisor. Make your Financial Plan. Will give you clarity, what amount is needed by you when in the future and how can you invest in the right way to reach it. Make your plan and stick to it. Consult the advisor once/twice a year to update the status of the plan.

14. No need to own more than 1 residential property
Investing in property is a big NO. Buy 1 for yourself where you will be living. For additional money, invest in Financial Products like Mutual Funds, they give you more transparency of valuation, with high liquidity your money is available to you in 3 days (whatever be the amount, whatever). Even if you need regular income, you can get it through the SWP option. No need of lengthy paperwork of real estate, taking care of maintenance expense of the property, searching for a good quality lessee etc. And its highly tax efficient too!

15. Complete your tax related investments/insurance in Jan
Don't wait for last week of March for completing your tax investments. Do it in Jan for this year and for next year try to complete by June 2020 rather than waiting till end of the year.

16. 0 Cost EMI
Deal with it carefully. Buy only the products which you need at 0 cost EMI. If you can afford to buy by paying full amount always better to get benefit of 0 cost EMI. If not, don't fall into the trap of 0 cost EMI. Ultimately you have to pay it off and you may end up with not much needed expensive products, just because it was available at 0 cost EMI.

17. Open bank account for your kids and pay them pocket money in that
Teach your kids about finances. What better way than having their own bank account, their own ATM card. Give them freedom to use money (to the extent of their pocket money). Wise lessons are learnt only by practising.

18. Go Cashless
Use less cash this year. With wallets and UPI BHIM QR codes being accepted all across you can easily afford to go cashless. Saves you from lot of hassles of cash handling and visits to ATM. Also its absolutely safe, secure and easy.

19. Pay off your loans
Make it your first priority to pay off your outstanding loans. If you are having both loans and investments together, it's always better to pay off the loans and feel the relief rather than leveraging yourself.

20. No share trading
Stay away from share trading. Remember that the person who makes most money in share trading is the broker. If you want fun and excitement in life go visit a casino or a theme park like Imagica or Universal or Disneyland. Money making is not so easy as it looks like in share trading. If it was so rewarding, share traders would be world's richest people.