Most financial advisors are scared to scale down the return expectations of clients. In the Indian context it is easy to see why. If you tell a client that he will get 8% in a debt fund, most middle-class clients are going to turn around and say “I am investing Rs 600,000 a year in 4 PPF accounts, and Rs 200,000 in NPS so my debt appetite is already met”. Similarly, the FA who says “10-12% return in equity” will be scoffed at even in FA meetings! It is as though the FA thinks that the returns that a client gets is a function of what the FA says!!
In the US, the return expectation for the next decade is pretty bleak. For stocks, Jason Zweig, a columnist, says he combines dividend yield with projected earnings growth, which he expects to be about 5% over the next decade. That translates into a roughly 4.5% return on a 60% equity/40% bond portfolio, and even lower for more conservative portfolio mixes.
Let us apply this to an Indian scenario. The current dividend yield is about 1.5% on the Sensex, projected earnings growth of 9%, yes our current PE of the market is high, but I am not sure of the PE of the mutual fund portfolio, let’s leave it unchanged. That makes the return expectation on equities about 10.5%. For bonds, current yields are about 7.5% for the 10 year G-sec and high quality corporate bonds are about 9%p.a. Now if you take a haircut for expenses, you come to a pretty unimpressive 9.5% equity projection and an 8% debt projection.
Safety, taking care and diversification are much better than fortune telling which I have done. I could be wrong by a long mile, so do not assume that these numbers are sacrosanct for a whole decade.
Saying ‘such low returns’ so I will NOT invest at all is also very foolish, because keeping your money under your bed does not help either. Cash has proved to be a terrible asset, and expect PPF and NPS returns to drop.
You need to keep your asset allocation in mind and use volatility to your advantage – entering the equity market a little too early or staying there a little too long when the party is over will not hurt you as much as not being in the party at all.
Low cost bond funds will capture some of the portfolio valuation return which a bank fixed deposit or PPF will not.
SIP in debt funds and SIP in equity funds is possible, remember PPF is a brilliant product only if you are already seeking inflation protection through equities. Balanced funds and Multi-Asset Allocation funds are more tax efficient.
Your portfolio is dynamic, and so is your fund requirement, so if in an equity boom year if you need money, your asset allocation may change, because your draw down can happen from equities instead of debt (assuming Retiree portfolio).
The advantage of starting with a low expectation is that in case you end up getting a higher return, you are still waiting for the ‘regression to the mean’ which may not happen at all in your investing period. In 10 years’ time your risk profile, net worth, etc. would have changed – and your portfolio too!!
PV Subramanyam
writes at www.subramoney.com and has authored the best seller ‘Retire
Rich - Invest C40 a day’