ATM :: How do you estimate long-term returns on equity investments?

By ET Bureau | 23 Jun, 2014, 02.32PM IST


Meena Prabhu is a systematic investor in equity funds. She earns well, has a comfortable lifestyle, and is single. She does not have any specific financial goals, but is keen to see her money grow. She finds it easy to use SIPs to invest regularly. However, the size of the returns is her concern. How can she evaluate her investments?

Meena should bear in mind that returns from investments occur in the future. They can only be estimated. There are no guarantees. Her focus should be on the processes she follows in choosing the equity funds, the timing of her investments, and the duration for which she invests. She will protect her investments from high risks by using a sound process, and will earn market returns on her investments.

How can she estimate the returns? The easiest way is to look at the historical returns. When it comes to equities, returns can be very volatile. But if Meena diversifies her investments, invests consistently without putting too much money at any single point in time, and invests for the long term across market cycles, her returns are likely to be close to the long term average. By using SIPs, she is following this process.

Long-term returns from equity investments tend to beat inflation numbers. The ability of equities to earn a higher return comes from businesses being able to use borrowed funds, invest them in assets and earn a return that is higher. This business risk is compensated by the risk premium on equity investments. Meena will find that in India, the average long-term return from investing systematically has been about 14-16%. This, after several sharp shortterm ups and downs.

Therefore, Meena should not expect to earn a steady return every year — and be prepared for market volatility, which tends to average out over time. But, since her investment process is designed to reduce risks, she should do well, given her long-term orientation.

(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre and Arti Bhargava)

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