Shaina should know that investment returns occur in the future and therefore can only be estimated. There are no guarantees in the world of investing, let alone in stocks. She should focus on the processes she follows to choose equity funds, when she invests and the time period she invests for. It will protect its investments from high risk using a sound process and will earn market returns on its investments.
Now the question arises, how can she estimate the returns? The easiest thing to do would be to look at historical returns and form expectations based on that. With respect to stocks, returns can be very volatile. However, what Shaina will notice is that if she diversifies her investments so that she holds a basket of equity shares; invests regularly without investing too much money at one time; and ensures that it remains invested for the long term through market cycles, its return is likely to be close to the long-term average. By using SIP, it follows this process in its investments.
The long-term return on equity investments tends to beat inflation numbers. The ability of equity to generate a higher return comes from the fact that companies can use borrowed funds, invest them in assets and earn a higher return. This business risk is offset by the risk premium on equity investments. Shaina will find that in India, the average long-term return on systematic investment has been around 14-16%. This will decrease if inflation decreases in the future. This will also be subject to some serious short-term ups and downs. Therefore, she should not expect a steady return every year, but expect ups and downs, which tend to even out over time. As its investment process is designed to reduce its risks, it should do well given its long-term orientation.
Content on this page is courtesy of the Center for Investment Education and Learning (CIEL).
Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.