Motilal Oswal Asset Management Company Ltd. (MOAMC) is a public limited company incorporated under the Companies Act, 1956 on November 14, 2008, having its Registered Office at 10th Floor, Motilal Oswal Tower, Rahimtullah Sayani Road, Opposite Parel ST Depot, Prabhadevi, Mumbai - 400025.
Motilal Oswal Asset Management Company Ltd. has been appointed as the Investment Manager to Motilal Oswal Mutual Fund by the Trustee vide Investment Management Agreement (IMA) dated May 21, 2009, executed between Motilal Oswal Trustee Company Ltd. and Motilal Oswal Asset Management Company Ltd.
Close

Setting the right time frame and expectations from the equity market

Blog Blog Details
  • November 12, 2021
  • Devanshu Tayal|
  • Passive Funds
Introduction
The covid-19 has triggered uncertainties almost everywhere, and the Indian economy is one among them. While some people suffered from unemployment & salary cuts, others made their way to finding passive income sources and found that investments in the stock market could be one of the ways to generate income & ensure financial security. The subsequent lockdowns & the work from home culture additionally presented people with more time, & thus leading to this shift. 

A strong inclination of retail investors was observed in the stock markets when the pandemic was weighing down heavily upon us. As per the data released from the SEBI, there has been a massive growth in Demat accounts in India post-Covid (data shown in Exhibit 1 below), with the number of new accounts between April 2020 and January 2021 doubling from that in FY 2020.

                                    Exhibit 1
    Source: Livemint as of 9 March 2021

However, these Covid-led uncertainties have also spurred many individuals to stock market investment with less or almost no experience in the equity space. Even most "Robinhood" investors know only one side of the market, which may lead them to form reasonably high return expectations from their brief investing journey. Skilled traders, on the other hand, might suffer from recency bias of post-Covid-19 bull run. 

Hence, to understand how much you need to save and invest, you need to have a realistic expectation of returns from your investments.

Why is having the right return expectation essential?

There is nothing wrong with wanting the best ROI for yourself. However, with that said, unrealistic or high return expectations from the market can also do more harm than good. It can ruin your planning, starting right from achieving financial goals to savings. Let s understand this with an example. Assume you want to fund your child s higher education abroad and need about Rs 38 lakhs in 10 years. You assumed that you could obtain a CAGR of 20%; hence you arrived at a monthly SIP of Rs 10,000. But what if you end up averaging a 12% return on your monthly investments? The shortfall will be massive (nearly about Rs 15 lakhs), and it will not only ruin your complete financial planning but leave you in a pool of emotional distress. 

And, when such situations happen, we are likely to lose hope & faith in the equities. Consequently, we look for other attractive asset classes and hamper the compounding process. It may lead to suboptimal wealth creation, and ultimately, our financial goal remains unfulfilled. Thus, it is imperative to have realistic expectations and hope for positive outcomes rather than shocks.

How can one form a return expectation from the market?

By and large, people set their return expectations by either benchmarking them against their family/friend s performance or looking at their favourite stock return. Many new investors witnessed the Nifty 50 PR Index doubling from March 2020 and making big from the market. But, is it going to be like this forever? Can you expect returns like this in the future? Nobody can foresee the future, but if we look into the history of the Indian stock market, it has never seen such a V-shaped recovery post any crisis. In the long term, Sensex, i.e., India s oldest equity index, delivered a CAGR of 15.4% since inception (Source: BSE India as of 31 July 2021). 

It is also interesting to observe that some people assume the nature of returns from the stock market is like fixed deposits - where the CAGR promised will be credited to your account at the end of each year. But, unfortunately, equities have a much more volatile nature. That s why the industry prefixes the equity CAGR with Long-term . Therefore, investors should decide on the time frame for staying invested in the markets. It is one of the fundamentals that help us form any return expectations. 

When making return expectations, you must answer the following to make the right decision. 
  1.   What is the benchmark of your return expectations?

  2. What is the time frame for which you want to remain invested?

  3.  What is your risk profile?


Let s discuss them all & help you find answers to them.

Benchmarking of your return expectations with inflation:

But, first, let us first understand what does Real Returns mean? Simply put, the real return is what you earn on investment by accounting for inflation. As per the guidelines, fixed income products generally offer 1.5% - 2% over inflation to compensate for the loss of purchasing power. However, since an equity market-linked product is much riskier than a fixed-income product, it should beat inflation by a higher margin. Thus when you link your return expectation to inflation (rather than relying on random numbers), you make better investment decisions. 

Let s have a better understanding of the relationship between inflation & returns through some historical data. (Shown in Exhibit 2) 

Exhibit 2
Source: NSE, GOI, WB, Data as of 30 December 2010 – 30 December 2020. All performance data in INR. Inflation has been smoothened using linear interpolation. Hypothetical performance results may have many inherent limitations, and no representation is being made that any investor will or is likely to achieve the performance similar to that shown. The above graph/table is used to explain the concept and is for illustration purposes only. It should not be used for the development or implementation of any investment strategy. Past performance may or may not be sustained in future.

1.The market generally beats inflation for any three years, excluding major crash phases like the Covid-19 pandemic.
2.In the graph, decreasing inflation (approx. from 12% in 2010 to 5% in 2020) shows that one doesn t need to earn a high return to stay ahead of the price rise.
3.In a nutshell, one can link their return expectations with inflation. Therefore, be aggressive when inflation is high and moderate when it is decreasing.

Exhibit 3 shows the data of the market returns over inflation. It indicates that neither a very high inflation (3 years average ending 2013) nor meager inflation (3 years average ending 2019) is favorable for the market. 

We can see that the Real returns performance has steadily come down with decreasing inflation in the past ten years. So, what does this mean? While we want Inflation + X% as returns, the X varies on various internal and external factors like economic growth, liquidity, currency movement, etc. Let s just save the discussion for another day & move forward!

 Exhibit 3   
 
Source: NSE, GOI, WB, Data as of 30 December 2010 – 30 December 2020. Avg 3 Year CPI for 2013 is calculated by taking an average CPI (Annual %) of 2010-2013 and similarly for other years. All performance data in INR. Hypothetical performance results may have many inherent limitations, and no representation is being made that any investor will or is likely to achieve the performance similar to that shown. The above graph/table is used to explain the concept and is for illustration purposes only. It should not be used for the development or implementation of any investment strategy. Past performance may or may not be sustained in future.

The retail inflation or consumer price index (CPI) is currently at 6.26% for June 2021 (Source: MOSPI), slightly more than the RBI mandated 4% with a limit of 2% - 6%. 

Setting the right time frame for your investments:

Now that you know how to benchmark your expectations against inflation, it s time to choose the appropriate time frame to reap the maximum benefits from the equity market. You must have heard from your friends and family that equity markets are highly volatile & may deliver negative returns. Is it true? Can equity markets make you lose your invested money? Let s uncover the reality by analyzing the following data (Exhibit 4).

Exhibit 4 
Source: NSE, Data as of 30 August 2006 – 30 August 2021. All performance data in INR. Hypothetical performance results may have many inherent limitations, and no representation is being made that any investor will or is likely to achieve the performance similar to that shown. The above graph/table is used to explain the concept and is for illustration purposes only. It should not be used for the development or implementation of any investment strategy. Past performance may or may not be sustained in future.

As seen from the table, the investments made in equity for more than five years had negligible negative returns (rolled daily). However, it means investing in equity for the short term can be a risky bet, and odds might not be in your favor. This leads us to a conclusion - A longer time frame safeguards us from the risk of negative returns. 

"Since I belong to the passive funds industry, I feel obliged to share that replicating above with pure-play beta funds such as index funds/ ETFs is more accurate than taking exposure to the indices via other semi-active/active funds. As history teaches us, there might be a bad fish in the sea of mutual funds offered, and you never know if yours is a bad one. Passive funds greatly eliminate the uncertainty of picking the wrong fund as well as they replicate the benchmark subject to tracking error!"


Now that we know that you need a time frame of at least five years for equity-related funds to keep your losses at bay, let s analyze how much returns the indices have delivered so far? Remember, we have discussed the double-digit returns in the beginning? So we are going to analyze that now!

Exhibit 5 
Source: NSE, Data as of 30 August 2006 – 30 August 2021. All performance data in INR. Hypothetical performance results may have many inherent limitations, and no representation is being made that any investor will or is likely to achieve the performance similar to that shown. The above graph/table is used to explain the concept and is for illustration purposes only. It should not be used for the development or implementation of any investment strategy. Past performance may or may not be sustained in future.

The above table shows that the above indices have an average 60% chance of delivering double-digit returns when the time frame is greater than five years. However, investors need to realize that even if the long term CAGR is double-digit (shown in exhibit 6), you may fall in the 40% chance of earning less than 10%. 

 Exhibit 6
Source: NSE, Data as of 30 August 2006 – 30 August 2021. All performance data in INR. Hypothetical performance results may have many inherent limitations, and no representation is being made that any investor will or is likely to achieve the performance similar to that shown. The above graph/table is used to explain the concept and is for illustration purposes only. It should not be used for the development or implementation of any investment strategy. Past performance may or may not be sustained in future.

Identifying the Risk Profile: 

Financial markets inherently come with risks. Hence, risk profiling becomes imperative, as it helps you with proper investment basis asset allocation & mitigation of specific risks. 

Every investor has a different risk profile depending on their age, lifestyle, income & financial goals, etc. However, overall it is a factor of:
a. your ability to take the risk
b. your willingness to take risks

Your investment advisor/financial planner may help you conduct a simple risk assessment to assess a risk profile that determines the amount of capital you may allocate to equity as an asset class. The risk of equity is measured by considering standard deviation. Higher the standard deviation, higher the risk in the investment. But we also know high risk equals high returns. Let s refer to Exhibit 7 below.

Exhibit 7
Source: NSE, Data as of 30 August 2006 – 30 August 2021. All performance data in INR. Hypothetical performance results may have many inherent limitations, and no representation is being made that any investor will or is likely to achieve the performance similar to that shown. The above graph/table is used to explain the concept and is for illustration purposes only. It should not be used for the development or implementation of any investment strategy. Past performance may or may not be sustained in future.

Moving from large-cap to small-cap, we can see a gradual ascend in terms of volatility. High volatility may be riskier. But, it is up to you how much you can bear and accordingly allocate the capital to your preferred equity class. 

To recapitulate the essentials, 

If you need to form the right return expectations from the equity market, you must remember that 

  1. Your return expectations match up with inflation. You do not have to make much of a return to beat inflation.

  2. Non-double-digit returns are not the only markers of equity being under performing.

  3. The right time frame is equally crucial for you to plan savings accordingly & generate wealth without any worries.

  4. Understand your risk profile and choose the equity-related instruments suitable to your needs, goals, and interests.

Disclaimer: This article has been issued based on internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The stocks/sectors mentioned herein explain the concept and shall not be construed as investment advice to any party. The information/data alone is insufficient and shouldn t be used to develop or implement any investment strategy. It should not be construed as investment advice to any party. All opinions, figures, estimates and data included in this article are as of date. The article does not warrant the completeness or accuracy of the information. It disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken based on this article. Mutual Fund Investments are subject to market risks; read all scheme related documents carefully
Share this articles
  • FB Comments
Facebook comments not available
Newsletter
Connect with us
+91-22 40548002 | 8108622222
CIN-U67120MH2008PLC188186

Mutual Fund investments are subject to market risks, read all scheme related documents carefully

KYC is one time exercise while dealing in securities markets - once KYC is done through a SEBI registered intermediary (broker, DP, Mutual Fund etc), you need not undergo the same process again when you approach another intermediary

Site best viewed in IE 9.0+, Mozila Firefox 4.0+ and Google Chrome at 1024 x 768 pixels resolution