What is a good return to earn from your investing? In the absence of any accepted benchmark most are prone to thinking that higher is better. And the mutual fund industry has made beating the benchmark index eg Nifty 50 the minimum that must be crossed and by a margin to be considered the mark of good investing. But in the matter of earning returns the paradox of ‘more is less’ beyond a certain point is very apt. Why is it so and what’s the ‘right’ answer?
Last year I conducted quite a few webinars on Investing successfully when I asked people what returns they expected to earn from investing in stocks. The most common answer was 20-25% CAGR.
Are you also expecting 20-25% returns?
When I ask why this number, the conversation goes something like this
Them: kyon ki hum riks le rahein hai, bhai. I can almost see everyone nodding in agreement.
Me: Oh, you mean risk.
Them: Wahi toh, riks, toh 20-25% toh banta hai.
The only difference with the urban English educated gentlemen was that they know its risk and yes, they expected the same reasonable returns, CAGR.
Smarter ones: Market toh 12-15% deta hi hai. So when we come to you, you must get us something more like 25%.
Me: I hold onto my patience but only by a thread and then say nicely, atleast sometimes: If that was so doable, why would I or anyone capable of doing this waste time talking to you. They would borrow lots of money at 12% and earn double of that. And every other mutual fund would be delivering 25% CAGR.
Most people go silent after hearing this, they didn’t expect me to be so candid, at least not so early in the webinar. They are probably disappointed or angry that I bust their bubble. I think some leave my webinar sure that I am an idiot who does not know how it’s done and is making excuses.
Then if I am lucky there will be a Munnabhai in the group who will ask: Yeh CAGR kya hai?
It’s Compounded Annual Growth Rate.
Bole toh, every year you earn this returns on your principal amount and the returns you have earned previously
Interest pe interest.
Aisa bolo na. Bole toh kitna time me paisa double ho jayega?
24% CAGR se 3 saal mein.
Aare Circuit, yeh to apne dandha se bhi accha hai, kitna amount se start kar ne ka. Ek, nahi 2 khokha theek rahega? Apne ko thoda kam bhi chalega Raymond ji, tension nahi leneka.
Jokes apart, most people get it that 20-25% is unreal in today’s context in India where the interest on FD is about 6% which doubles your money in 12 years. But they have heard of so and so is earning this kind of returns or someone is ‘promising’ fantastic returns and also showing proof of it.
And it stands out like and gets everyone’s juices flowing and I think their thinking brains are hijacked. They want to believe this, that this is happening to many people except themselves. I find women investors, on the other hand, are more skeptical about such claims and promises.
What you need to remember is that you come to know about the rare investors who made extraordinary returns because the media, books, social media, marketers all showcase only those cases that succeeded and never those that failed. You wouldn’t buy a magazine or listened to them if they talked about failures and average investors, now, would you? No, but there are huge number of people gone and going bust trying to earn very high returns, you don’t see them or hear them. They may be sitting right next to you, too embarrassed to talk about it and maybe bragging about the one stock that he bought that is rocking while his portfolio is down in the dumps. And he is doing it because maybe, just maybe you did the same shit with him and he’s forced to play the my-dick-is-longer-than-yours, game.
Just drop this obsession with very high returns. Firstly, because you are not equipped mentally or otherwise to play the high risk-high returns game. The thing is that to earn high returns you need to take higher risk but taking higher risk does not guarantee you high returns. Most people and that includes you, even if you vehemently deny it, can’t digest losses even notional ones. So, when the market gets choppy, you get sea-sickness and puke i.e. sell when you shouldn’t. If not then probably worse happens.
You see some of your stocks down one hell of a lot and conclude that now it’s even more attractive and buy more of that shit- it’s called averaging down and it’s a trip that is very hard to avoid. Why because you fall in love with what you own, find it cute and can’t entertain the idea that you could have made a mistake. Ask a dog-owner whose pet is a grotesque looking thing and you just cannot understand why this regular looking person took this one as a pet of all the dogs that exists. My apologies to dog-kind and dog-lovers. It happens to all of us mammals because nature has tricked us into loving and caring for what’s ours, immaterial of anything, making us see good and feel even better. It’s a great human thing but transferring it to assets like stocks, is a recipe for disaster. It’s called ownership bias which is that we think whatever we own is more valuable than it probably is and can’t imagine how the market thinks otherwise, it has to be wrong.
This will happen immaterial of what stock, assets you own and therefore the trick is to fill your portfolio with lots of good quality, safe company stocks. But, then most often they don’t come cheap nor with the promise very high returns in the short run. More importantly, you cannot brag about such a portfolio. So, I suggest you find something else to brag about and leave your portfolio to do its job of growing steadily.
The second reason why you should stop chasing high returns is that you must understand the difference between being efficient and being effective.
Stephen Covey author of Seven Habits of Highly Effective People helps get the point across very clearly through the famous wall-ladder analogy. Climbing a wall with the help of a ladder in shorter time makes you more efficient but placing the ladder against the correct wall makes you effective. Placing the ladder on the right wall and using your enthusiasm and skill to climb it faster without falling makes your effective and efficient. If it placed on the wrong wall, you are not effective and efficiency does not matter.
Returns is measure of efficiency; its money earned divided by money invested in a given period of time. Sure, earning higher returns is being more efficient with your money. But if you are unable to invest sufficiently through this ‘higher-returns-way-of- investing’, or you are unable to stay invested for long enough then you will not meet your goals, making this way is an ineffective way of investing for you. It’s like climbing fast on a short ladder…. you don’t reach your goals no matter how fast you climb the ladder.
Investing effectively means you manage your investing in a way that you are able to provide for your goals. It’s like climbing a very tall ladder that is placed against the wall that has your goals right at the top. Climbing too slowly (earning lower than inflation rate) won’t get to the top in time and climbing very fast is not a virtue.
Math coming up. How does your investments grow? It grows by compounding which is by this formula. The compounding formula has 3 variables. Surplus (the saving you put to work), Returns (CAGR) and number of years you stay invested and earn the returns.
All 3 have a positive effect on growing your money, i.e. increasing surplus, returns and number of years you stay invested to earn this, increases your wealth. But, chasing very high returns means taking high risk and that creates two problems in the math. It adversely affects how much you invest and how long you stay invested in that investing strategy. So, it does not help you maximize your wealth. Instead, you need to manage your investing in such a way that it earns you significantly higher returns than inflation but keeps your discomfort within manageable levels to enable you to put all your surplus, saving to work and you stay invested in the strategy for long, really long, as long as you need to.
Now does this mean that at best you are destined to earn healthy but not spectacular returns. I wouldn’t complain if 40 years ago someone told me this was my destiny. Why do I say that? Have a look.
There is also something of a paradox that happens on returns when you manage your investing in this way. As your experience and confidence grows, you take better decisions, you spot high returns opportunities with no real increase in the risk and you learn to manage risk better. All this leads to higher returns, certainly higher than what you planned for and that means you are moving faster than your plan to reach Financial Freedom. So, read the book.