It’s a common problem; we invest with certain expectations, but, at maturity, we fail to achieve it. We wonder why does this happen and ask few questions to our-self –

Have I over expected it?

The option I selected was not correct?

Did I fail to understand the risk involved with that investment? etc.

We recognize that the actual growth of our investment has deviated from what we have expected. It’s a common phenomenon if the expectations are not realistic. But when maturities are targeted to accomplish a liability, it becomes a concern.

Let us discuss this in detail, why this happens –

Our investments grow as a result of financial changes which are influenced by many factors. Predicting the implication of such factors on our investment growth is challenging. A better understanding can only help reduce the gap between expectation & the actual outcome. The gap goes wider on investing in high-risk options but you have higher growth potential for your investments. So the growth & risk are inseparable.

Therefore, when expecting higher growth, be ready to accept the risk associated with it. Accepting; only one side of the coin does not erase the other side. Every investment has a greener side but also the other side bearing its limitations. Investment decisions taken based on both sides have a higher probability of growing them to your expectations. There is no investment having zero risk but a rational view on merits & demerits before deciding the investment option reaches us closer to realistic expectations. 

All of them including, so-called, safe investments have an element of risk involved. For example –

Provident Fund has a risk of changes in government policies,

PPF has a risk of equity market & interest variation,

Bank/ post office deposits have a risk of interest rate variation,

Equity shares have a risk of market volatility,

Mutual funds have a risk of market volatility/ interest variation etc.

So the risk is a part & parcel of any investment. It is our understanding of the investment that helps to select the appropriate one. That also helps to bring rationality to our expectations.

An understanding of some of the aspects can help to bring rationality to the expectations –   

1. The holding period plays a vital role in deciding returns.If you are investing in a market-linked product, the longer the holding period, the more the usage of the power of compounding and lesser the volatility in returns. Therefore, the returns expectations could be more realistic. 

On the contrary, the debt-related product, the longer the holding period, the more is the risk of interest variation. Therefore, returns expectations based on current interest rates may not be realistic. 

2. Past performance cannot be a guarantee to future performance.You have to be rational enough while projecting your returns based on past performance. Unless we understand the logic behind past performance and conclude the same to continue, we cannot take the same value. Moreover, in the lack of such information, it is better to discount the expectations to achieve certainty in returns.

3. Not reviewing representative databases is a common mistake people commit.We expect returns from bank deposits based on the current rate of interest for the entire post-retirement period. We forget, at every renewal, the prevailing rate of interest may or may not remain the same. A short-term five-year interest rate can’t represent the thirty-year long post-retirement phase. To assess this variation, we must review 30-40 years of historical data. The realistic expectations could come only when we go through its long term data. Similarly, we expect the returns from a mutual fund scheme in the short-term, based on its long term performance. Therefore, the selection of representative data for review is an important aspect.

4. Acknowledging the risk associate with any investment must be considered to discount the expectations. For example, investing in bank deposits for 20 years carries an interest variation risk and investing in pure equity mutual fund carries a market volatility risk. Market-risk can be reduced by increasing the investment holding period but, interest variation risk can’t be. By selecting an appropriate investment option, the associated risk reduces to a greater extent. That can help in drawing the expectations more realistic.

5. We consider the current rate of taxation for future returns also,forgetting, it has a probability to change every year.This aspect can reduce the returns in hand. Even government-backed schemes like provident funds can also come under taxation. An appropriate discounting on such accounts can bring the returns closer to the realistic one.

Conclusion –

Understanding investment options can help predict realistic growth with a possibility of variation from the expected values. The acceptance of such variation brings clarity and makes the expectations flexible enough to accept. That is equally true across the investments. Fund growth and risks associated with them have very close relations, and you don’t have a choice to exclude either.