scorecardresearchWhy should investors aim for moderate returns and take low-risk bets?

Why should investors aim for moderate returns and take low-risk bets?

Updated: 04 Jan 2023, 08:02 AM IST
TL;DR.

Instead of focusing on taking higher risks to get potentially higher returns, it’s better to invest a bit more with lower return expectations.

Why should investors aim for moderate returns and take low-risk bets?

Why should investors aim for moderate returns and take low-risk bets?

While all of us ‘wish’ to generate Buffett-type returns in stock markets, the reality is that very few can get close to his investment track record. But let’s leave the gods of the investing world and come down to mother earth.

Investing is a lot like driving. Suppose you have a journey of 300 kms. Now you can start your journey with the assumption that driving at an average speed of 75 kmph, you will cover the distance in 4 hours. Or you can assume you will drive at 120 kmph and reach in 2.5 hours. As you might have guessed, the risk of driving at 120 kmph on Indian roads is obvious (expressways are improving by the way!).

So, for all practical purposes, it’s better to start early and assume that even with average speeds (of say 75kmph), you will reach in 4 hours instead of starting late and relying on driving fast alone to reach the destination on time. Isn’t it?

The same is the case with investing as well.

When you invest in equity markets, it’s natural to aim for high returns. And that is why you are coming to markets for. But you should not depend on it. Just like you should not depend on your skills to drive fast to reach the destination on time.

An investment example here will be helpful

Investor A – He believes in his fast driving skills! He plans to accumulate 1 Crore in 10 years’ time. He also expects that he can easily generate 18-19% average returns. Accordingly, he would have to do a monthly investment of about 30,000 for the next 10 years in a mutual fund portfolio.

Investor B – She knows driving very fast can be risky. She too plans to have 1 crore in 10 years. But she doesn’t want to depend on high returns alone. She expects 12% returns and will invest 43,000 monthly (which is higher than what the other Investor-A will do).

What is happening here is that both investors are aiming for the same goal ( 1 Cr in 10 years). But they are taking different paths. Investor A is taking the high-risk-high-return way and investing less and expects to generate higher returns. Investor B is taking a moderate return assumption and investing a higher amount every month. And that is because she doesn’t want to rely on very high-risk investments.

To summarise, one is taking higher risks to get higher returns and is investing less. The other is taking lower risks, not relying on high returns, and investing more.

If I were to ask you which is a better option and which increases the probability of goal achievement, then I am sure you would say it’ s Investor B’s strategy.

And that is what this article aims to prove.

I am not saying you should not try to generate high returns. I am saying that you should not depend on it. More so when you are saving money for real-life goals like children’s education, retirement, etc.

So instead of focusing on taking higher risks to get potentially higher returns, it’s better to invest a bit more with lower return expectations.

Stop here and recall the driving example we took earlier. For a 300 kms journey, it is better to start early and drive moderately than start late and drive fast.

Unless you are an investor with superlative stock-picking skills, your savings rate (i.e., the money you invest) will play a far bigger role in how much wealth you create than the returns you generate. This is true at least for all the initial years of your long-term goals.

It is of course possible that you may not have the kind of (full required) surplus that you need. In that case, first, try to do what you can.

That is, for example, if you require 50,000 monthly to invest fully for all goals (you need to calculate the right SIP amount) and you only have 35,000, then start investing that 35,000 instead of waiting for the availability of the full amount. Later on, as your income increases, you can gradually increase your investments as well.

Dev Ashish is a SEBI-Registered Investment Advisor and Founder (Stable Investor). He provides fee-only financial planning and investment advisory services to small and HNI clients across India.
 

Article
This is the difference between NPS and SIP
First Published: 04 Jan 2023, 08:02 AM IST