When you have a financial goal to accomplish then you need to make investments on a regular basis. The returns that these investments generate will give compounded returns. Read more about the compounded returns here.
However, these returns will also be subject to taxes, and what you eventually get in hand will be post-tax returns only. On the top of it, these returns will not appear as big then as they appear now, thanks to the inflation. Very rightly, ace investors Warren Buffett said recently that inflation swindles everyone.
Then what should be your rate of return that can ensure that you, in fact, accumulate your corpus in reality and not only on paper. This can happen when you factor the expected inflation, income tax as well as likely rate of return on your overall investments i.e., equity and debt.
This rate of return is known as minimum acceptable return (MAR).
In other words, it is the minimum acceptable return at which your investments must grow to accumulate the required amount for a life goal.
This is quite vital and can be used for asset allocation. For instance, when your MAR is 10 percent, then you should invest in equity and debt in the right proportion so that their expected weighted return of the portfolio matches the MAR.
|Amount invested every month:
|No of EMIs:
|Minimum acceptable return
|19% (with inflation at 6%)
|After tax (20%)
As shown in the table above, if you want to accumulate ₹10 lakh in a span of five years and can spare only ₹15,000 in a month, then we want to find out the minimum return that is required to achieve the target of ₹10 lakh.
So, the minimum return has to be 13 percent and after factoring in inflation of 6%, one must get a return of 19 percent.
Key factors to consider while computing MAR:
1. Before calculating the return, it is imperative to factor in inflation, without which the calculations will be nothing but misleading.
2. As you factor in inflation, it is important to reduce the income tax outgo as well to compute the net return in hand.
3. The returns on equity, debt and precious metals are varied. So, the correct will be the weighted average return on all the returns combined.
4. The future returns and hence, the future value is based on expectations. So, the final compounded returns may actually differ from what you expect. As a result, the rate of return should be seen as the “minimum” acceptable and not maximum.
And in case you realise that the returns fall short of what are required then you need to raise the quantum of savings. So, the only safe and sure-fire way to maintain your MAR and accumulate the target amount is to increase your savings.