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Wednesday, March 26, 2014

Investments need time to grow

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Wealth generation can be defined as the amount saved and the return generated over and above the inflation rate for a long period of time.


Here, the three important factors to bear in mind are:

1.       Savings which effectively mean maintaining expenditure lower than income.

2.       Generating real rate of return, that is, return over and above the inflation rate.

3.       Generating real rate of return for a long period of time.


So, it is imperative that you curtail expenditure to generate capital for investment and put that capital in the right assets to generate a return much higher than inflation and maintain such a high ‘real’ rate of return for a long period of time. Returns generated by equity funds have proved that this is the best way for wealth generation.


Here, we are taking some examples to prove the same. We are assuming an investment of equal amount (Rs 10 lakh) in equity schemes of five large fund houses for 5-, 10- and 15-year periods. Past data show that between January 29, 1999, and January 30, 2014, despite substantial volatility, these five funds generated strong compounded annualized growth rates (CAGRs) of 22.6% over 15 years, 17.6% over 10 years and 21.6% over five years, while the average consumer price inflation (CPI) for the last 15 years was around 6.56% (See Table 1: Making one-time investments).


Similarly, for systematic investment plans (SIPs) of Rs 2,000 in each of these funds, the CAGR generated was 20.7% over 15 years, 13% over 10 years and 9.7% over five years (See Table 2: Opting for SIPs).


Historic returns give us compelling reasons to invest in equity schemes, although most of us have not generated such massive returns. A clear understanding of equity as an asset class for
long-term investment helps in overcoming the fear and greed. The basic factors which you should consider are as follows:


Investment allocated for long term only should be invested in equity schemes. The big question here is how long is a long term? This can be above 10 years and ideally above 15 years. Because, longer the investments are held, higher the effect of compounding in multiplying the corpus.


Investors should always be ready to accept capital erosion after making the investment. If we consider three-year annualized rolling return for the above five schemes for a period of 10 years, the worst return is the negative CAGR of 18.5% and the best return is a positive CAGR of 85.5%. The average return is at a CAGR of 25.5%. A long-term investment horizon helps in navigating the volatility.


Take the help of an asset allocation model. A small portion invested in equity with abnormal return over a long period cannot enhance the overall wealth. So the key to substantial wealth creation also lies in allocating sufficient amount in equity investments.


Accept that systematic investment is as volatile as one-time investment in equity. In a declining trend, SIP also generates negative return. So, SIPs need to be for the long haul.


Take time to invest and give time for the investment. Even one-time investment should always be spread over a period of one-two years through systematic transfers.

For further information contact Prajna Capitalon 94 8300 8300 by leaving a missed call

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