Investment decisions are typically made with the expectation of a certain return against the investment over a period of time. The rule of thumb is higher the risk of the investment, higher the return expectation.
To understand this in detail, we need to know the types of returns – absolute, and annualised (also called compounded annualised growth rate, or CAGR).
Absolute returns are the total returns you gain from an investment, irrespective of the period you hold it for. For example, if you bought a share of Reliance Industries for Rs 1,000 three years ago, and it is trading at Rs 2,500 today, your absolute return on the investment is 150%. However, absolute returns don’t help in comparing between two investment opportunities, as the time, capital and investment horizon varies between different investments. Hence, to make it more comparable, we have annualised returns.
Annualised returns are the Return on Investment, you receive per year (compounded) on your investment. Continuing with the same example from above, if you bought a share of Reliance Industries for Rs 1,000 three years ago, and it is trading at Rs 2,500 today, using the CAGR formula, we can calculate the annualised return.
CAGR formula = ((End Value / Beginning Value) 1/No. of years) – 1
CAGR = (2,500/1,000) ^ (1/3)-1
By this formula, we get that the CAGR for your investment is 35.72%, which is a very good return to get in the long term. It is worth noting that this return will never be linear over the holding period, as markets have bull runs, consolidation phases and bear runs. The stock may have zoomed from Rs 1,000 to Rs 2,450 in the first one year itself and the next two years to move up the remaining Rs 50. One can never guess how a stock will react depending on the market dynamics. The key is to stay invested over the long term and reap the rewards of compounding.
We now come back to our question, what is a good return to expect? That depends on your risk appetite, and the ability to hold on to stocks during the difficult market conditions. But historically, a return of 12-15% per annum compounded over the long term is considered very good, as this will grow exponentially as time goes by. However, such returns are difficult to achieve year on year and will vary depending on the market conditions.
For example, if we invest Rs 1 Lakh in a fund offering 12% returns per annum, and don’t touch it at all, with the returns reinvested in the fund, we are looking at a corpus of Rs 26.74 Lakhs in 30 years. This is without adding anything to the fund, and just letting the returns compound for themselves.
Warren Buffett, who is arguably the greatest investor of our time, has generated a consistent 20% return for Berkshire Hathaway shareholders since 1965. By simply doubling the performance of the S&P 500 in the USA, he has generated 2472627% returns as compared to the 15019% returns of the index in that period. It is also well known that Buffett has earned 99% of his current wealth after the age of 52. Hence, there is no bigger endorsem*nt to staying invested and looking at the bigger picture.
In conclusion, one must look at sustainable long-term benefits of investment, as they will compound over a period of time. Return expectations can vary, depending on the level of risk of the investment but anything between 12-15% annualised can be considered a good rate of return.
