# There is more to investing than obtaining real returns

Here is a set of slides from the recently concluded Chennai investor meet that hopefully might convince you that a real return is only one side of the investing coin.

Consider some product or a service or a fee  that costs 10L today.  For an inflation rate as shown below (8%), the cost will increase with time as shown by the blue line.

The green line represents the growth of the monthly investment amount at the average annual interest rate as shown above.

After 19 years the value of the investment will overtake the cost. Meaning we would have to wait 19 years to make the purchase.

The real return (approximately) in this scenario is 12% -8%  = 4%

Now, what if the inflation was 10% instead of 8%?

When the inflation increases to 10%, it would take 30 years to make the purchase for the same investment.  The return is still above inflation, but the does not help much. The purchase is significantly delayed. Why?

Now consider this,

More than double the investment, with less than half the return, a real return of about -2% produces the same result as a real return of +4%: purchase after 19 years.

What if we invest like we would expect a real return of -2% in an instrument that would give us a positive real return?

What if we invest 10200 each month in an instrument that has the potential to deliver double digit returns?

Unfortunately, many do the opposite. They invest less that the required amount (10,200) in instruments that offer negative real returns.

Loss of capital

Loss does not always mean a negative balance or an actual decrease in value.

The result: permanent loss of capital (notice the gap between the curves at 19 years). I use the word permanent because these are the people who are scared of notional short-term losses.  They may never be able to make the purchase.

Not investing enough is an ailment that can affect those who hope to earn a real return too!

A real return of +2% means nothing if one does not invest enough.

There is yet another side to this story.   Those who can only invest little (say 1500 pm) cannot take excessive risk in the hope of getting higher real return. This scenario,

can be produced in an excel sheet but is unlikely in real life. At least it is quite uncommon.

What is the point of this post?

When an expense crops up (planned or unplanned) the only thing that matters is the money available us. At the point in time, the return we have got, and how much it is above or below existing inflation rates is irrelevant.

The goal behind investing is to obtain a big fat corpus.

The goal is not to beat inflation. The goal is not to obtain a real return.

The goal is to recognise the importance of inflation. Inflation can be overcome  in two ways:

1) investing in aggressive assets. That is in assets with potential to earn a positive real return (return higher then inflation)

2) investing enough capital. This could even be in assets with a guaranteed post-tax return lower than inflation.

You can beat inflation by investing in FD/RD or endowment policies by simply investing enough. See here for an example.

Don't criticize the product or the agent who sold it to you. Nothing wrong with the product. Most people want guaranteed returns without understanding that the associated price is a huge increase in the necessary investment.

The second suggestion  may sound bizarre to you.  I am not suggesting you do that, for that would be an inefficient way to work your money.

I suggest that you combine the two ways:

Invest in an aggressive asset like equity, a sum that you will have to invest in a non-productive asset (like fixed deposits or endowment policies).

That way you can go beyond goal-based investing and create wealth. That is, have a surplus relative to your expenses at any point in life ... after a certain age.

There is more to investing than real returns. You need to invest as much as possible and as often as possible. Otherwise high returns won't amount to much.

Note:  I have received several requests to share the slides of the investor meet. My slides are not annotated and will be of little use to you in the present form. I intend to release them as a short booklet after the Bangalore Investor Meet to be announced shortly.

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## 46 thoughts on “There is more to investing than obtaining real returns”

1. This is an excellent post that brings out a significant point with some great illustrations. The amount invested will need to be more if the real return is less. It may be possible to represent this in a graph too. There is nothing wrong with choosing debt products for a coonservative investor - as long as he understands the investment amounts needed today and in an ongoing manner to reach a future goal.

2. This is an excellent post that brings out a significant point with some great illustrations. The amount invested will need to be more if the real return is less. It may be possible to represent this in a graph too. There is nothing wrong with choosing debt products for a coonservative investor - as long as he understands the investment amounts needed today and in an ongoing manner to reach a future goal.

3. I would request you to send the slides to those who attended the chennai meet. For the others, you could send them later after you have done the annotation. Hope you would consider. Thanks

4. I would request you to send the slides to those who attended the chennai meet. For the others, you could send them later after you have done the annotation. Hope you would consider. Thanks

5. Thanks a lot for the post and eagerly waiting for the booklet as well after the bangalore meet and all the best for the Bangalore meet as well.

6. Thanks a lot for the post and eagerly waiting for the booklet as well after the bangalore meet and all the best for the Bangalore meet as well.

7. Excellent!!! and so true with perfect examples.
I think people must follow the Invest first and remaining Spend rather than Spend and remaining invest.
your write up boost us for more n more equity investment.

nJoy
Regards
JD

8. Excellent!!! and so true with perfect examples.
I think people must follow the Invest first and remaining Spend rather than Spend and remaining invest.
your write up boost us for more n more equity investment.

nJoy
Regards
JD

9. Interestingly, I find that for certain combinations of input parameters, there exists a window where your corpus built out of monthly investments exceeds the inflation adjusted cost of the desired asset. In short, if you miss the opportunity then, you can never catch the train. Do you find something similar in your excel?
I used a monthly cumulative compound interest rate for my calculations. What is this 'average annual return' in your calculations?

10. Interestingly, I find that for certain combinations of input parameters, there exists a window where your corpus built out of monthly investments exceeds the inflation adjusted cost of the desired asset. In short, if you miss the opportunity then, you can never catch the train. Do you find something similar in your excel?
I used a monthly cumulative compound interest rate for my calculations. What is this 'average annual return' in your calculations?

11. Very good illustration of effects of inflation and how it impacts real returns. When properly present nothing can beat graphs to convey the message. Loved the graphs which runs parallel to each other indicating your goal is a goner.

One of negatives I have found with Goal based investing is (to the extent I understood it), if you can comfortably achieve your goal (say with Debt barely matching Inflation), you can get passive and go with the least risky option. You can end up underachieving by choosing the easier option.

In such a scenario, should one recalibrate the goal and aim for something more? Like you mentioned “by creating wealth”, over and above the basic goals. Then the question is how greedy do you need to get? If you aim for too much of a surplus and invest in risky assets, there is a chance that you may end up not achieving your primary goal? In this case, the conventional Goal based approach doesn’t help much. How can I use the tools to – [quote] “go beyond goal-based investing”?.

What would be ideal is a calculator (your forte :)), which uses the risk/deviation in various investment instruments and predicts the probability with which you would achieve your primary goal for a given investment strategy. This would allow me to aim above my primary goal as long as there is high chance of achieving the main goal (say 90%). For instance, if I can achieve my goals with Debt, I would still want to invest in Equities to create maximum wealth, as long as I don’t compromise my main goal.

Such a probability based approach would enhance even the basic Goal based calculator. Right now it just says that since equity has higher overall average returns, you can achieve your goal by investing x% in equities (or particular asset class). But the minute you move to a risky asset (which has a higher deviation from average) the probability of achieving the goal comes down – this is not captured in the graphs. A calculator that predicts my final corpus(es), with various degrees of probability for a given asset allocation would be great.

1. Thanks for your views. Will think about the idea you have suggested. In my opinion, one must invest according to the risk profile of the goal and not our risk appetite. Then we are likely to end up with a 'little extra'

12. Very good illustration of effects of inflation and how it impacts real returns. When properly present nothing can beat graphs to convey the message. Loved the graphs which runs parallel to each other indicating your goal is a goner.

One of negatives I have found with Goal based investing is (to the extent I understood it), if you can comfortably achieve your goal (say with Debt barely matching Inflation), you can get passive and go with the least risky option. You can end up underachieving by choosing the easier option.

In such a scenario, should one recalibrate the goal and aim for something more? Like you mentioned “by creating wealth”, over and above the basic goals. Then the question is how greedy do you need to get? If you aim for too much of a surplus and invest in risky assets, there is a chance that you may end up not achieving your primary goal? In this case, the conventional Goal based approach doesn’t help much. How can I use the tools to – [quote] “go beyond goal-based investing”?.

What would be ideal is a calculator (your forte :)), which uses the risk/deviation in various investment instruments and predicts the probability with which you would achieve your primary goal for a given investment strategy. This would allow me to aim above my primary goal as long as there is high chance of achieving the main goal (say 90%). For instance, if I can achieve my goals with Debt, I would still want to invest in Equities to create maximum wealth, as long as I don’t compromise my main goal.

Such a probability based approach would enhance even the basic Goal based calculator. Right now it just says that since equity has higher overall average returns, you can achieve your goal by investing x% in equities (or particular asset class). But the minute you move to a risky asset (which has a higher deviation from average) the probability of achieving the goal comes down – this is not captured in the graphs. A calculator that predicts my final corpus(es), with various degrees of probability for a given asset allocation would be great.

1. Thanks for your views. Will think about the idea you have suggested. In my opinion, one must invest according to the risk profile of the goal and not our risk appetite. Then we are likely to end up with a 'little extra'

13. Dear Pattu Sir,

Excellent article as usual !! I wish I had found someone like you giving these advice earlier in my life. I had always lived frugally and saved regularly but failed to invest aggressively in equities. Always held a wrong notion that equity is ' Risky' and amounts to gambling . May be brought up in an era where Harshad Mehta happened and sowed doubts about the markets system as a whole !
Thanks for your valuable lessons Sir !!

14. Dear Pattu Sir,

Excellent article as usual !! I wish I had found someone like you giving these advice earlier in my life. I had always lived frugally and saved regularly but failed to invest aggressively in equities. Always held a wrong notion that equity is ' Risky' and amounts to gambling . May be brought up in an era where Harshad Mehta happened and sowed doubts about the markets system as a whole !
Thanks for your valuable lessons Sir !!

15. The average annual return is only the simple annual return but should be interpreted as the CAGR. Yes there is a window for reaching the goal. Haven't paid much attention it its size though. Thanks.

16. The average annual return is only the simple annual return but should be interpreted as the CAGR. Yes there is a window for reaching the goal. Haven't paid much attention it its size though. Thanks.