Whenever I do an article on returns and mention 18 per cent return, some reader will remark, “This is too high.” Of course, a few will say 18 per cent is not possible, may be 12 is possible; some others will say “as we become a developed country, returns can even go down to 4 per cent per annum”, or something like that.The fact is that none of us know what rate of return we will get over the next 30 years. Or even over three years. Fairly obvious, I think. We put a number because ‘Excel’ cannot work with “I do not know” as an input.
We assume that a Rs 5,000 per month SIP over 20 years at 12 per cent will mean there will be Rs 59 lakh in that fund. That’s all. It is just proof that ‘compounding works’. And also that Excel works fine. It does not mean that you will get 12 or 18 per cent in that fund. You may get 12 or 23 per cent return on the amount of money that you are investing. It is just an assumption. In real life, you will be watching it on a day-to-day basis. The important thing is you need to create funds that will remain untouched over real long periods. You know that you have a goal — say, children’s education — and you need a corpus for that. Assuming that you have a three-year-old daughter and you are accumulating money for her to do a decent education, you have no clue what career she is going to take. You are just creating a corpus for a higher education.
As time goes by, you will contribute more, either because you know that she wants to do medicine, or because your income has gone up. Or even because you feel that more money is required for higher education. When a client asks an agent “what return will I get”, the best is to ask him or her to read this article! None of us know how much return we will get over four weeks, or four years, or four decades. We just have no idea! However, you start a journey assuming that a client needs Rs 59 lakh in 20 years. So, he has to do a Rs 5,000 SIP for 20 years. If his returns fall over 2-3 years, the only thing he can do is to increase the SIP amount. Sadly, investors think the agent knows what return the investment will give. No, he does not. Not even the RBI Governor nor the Finance Minister will be able to say what returns you can get over such a long time frame.
We are all guessing. The important thing is, we will be seeing it on a regular basis. Every year, we get a number. Say, we get 8 per cent return in the first year instead of 12, we may not do anything. But if we get 8 per cent return for the first five years, we will take corrective action. We may increase the SIP amount to Rs 6,000 or whatever we can. In a worst case scenario, we may push the goal back by a year or two. Or scale down the goal. We may settle for a cheaper car, a smaller house, or ask our children to take a student loan.
We assume some numbers, so that we can use Excel. We will monitor it regularly so that we can take corrective action.
PV subramanyam
writes at www.subramoney.com and has authored the best seller ‘Retire Rich - Invest C 40 a day’
