Knowing How Much Your Investments Make
How much does the average investment make? That is a question at the forefront of every investor’s mind and rightly so. The whole purpose behind investing is generating returns and how much does the average investment make is a question that must be answered before you park your hard earned savings in different asset classes or investment instruments. Now, imagine if you are someone who has never invested before. When you are told that investing is a necessary part of attaining financial freedom, you will inevitably have two questions on your mind – how much would it cost and what returns will you receive. After all, without answering the question of how much does the average investment make, nobody can claim that investments can help beat inflation or topple the interest accrued on bank deposits.
How much does the average investment make?
Knowing how much your investments can earn is an integral part of investing. Now, when you invest in bank fixed-deposits, the interest rate is mentioned on your fixed-deposit certificate along with the maturity amount, and the investment time period. So, you really don’t need to estimate the expected return. However, with most other investment instruments, the returns that you eventually generate need to be estimated or calculated. Estimated returns is one of the major metrics that needs to be considered before planning your portfolio, in addition to aspects such as your risk profile, time horizon, and financial goals. It is commonly believed that risk is directly proportional to returns, i.e., higher the risk, higher will be the returns. For instance, when you invest in equities, your investment has the potential to earn significant returns, albeit at a higher risk.
Conversely, when you invest in the debt market, the underlying risk is lower but then, the returns also end up being less than those offered by equities. Even within equities this concept is visible. When you invest in large-cap companies, your risk is considerably lower as these companies are well-established and have a certain performance metric. However, the returns are also usually lower as there is limited scope for aggressive growth. On the other hand, if you invest in small-cap companies, the risk is much higher than large-caps but the potential returns are also much higher as these companies are slated for aggressive growth.
Historic returns across asset classes
Considering the historic returns on asset classes, a study by SSRN[1] states that, between 1992 and 2021, Indian equities offered nominal returns averaging 13.5% per year, while gold offered average returns of 10.5% per year, during the same time period. Between 1998 and 2021, bonds offered nominal returns averaging approximately 9%. However, upon considering the impact of inflation, the highest real returns were offered by equities, at about 6%. As discussed above, over the long-term, the equity asset class offers the highest returns amongst asset categories, while also posing the highest amount of risk to investors. Accordingly, you must decide how much to invest in equities based on your personal risk profile and return requirement. Many investors choose to limit their risk by investing only a part of their portfolio in equities and this is considered a wise practice as it offers you the possibility of high returns, while mitigating the inherent risk.
There are two things that you must understand while assessing the historical returns of an investment:
- It is not necessary that history will repeat itself. This means that just because an investment did well in the past, it is not necessary that it will do well in the future as well. Thus, you must also assess the future prospects of an investment instead of solely relying on past performance.
- Check the metric used for return calculation. Generally, returns are stated either as annualised or as compounded annual growth rate (CAGR).
Calculating returns on asset classes
It is impossible to actually ascertain the exact return on a future investment as the market is impacted by a variety of events and factors. However, historic returns and forecasts are considered as astute proxies to the same and, over the longer term, the investment market has always offered returns which are higher than the rate of inflation, thus helping you save and grow your wealth even during high price regimes. Before investing, you can use various online investment calculators to set your goals and ascertain your return requirements, and, based on these metrics, the calculators offer you a choice of investment options tailored to your needs. Further, you can use the following methods to calculate returns on asset classes after they are realised.
Stocks – Since stocks offer both absolute returns and dividend income, the returns on stocks differ from those on other asset classes. You can calculate the total rate of return by adding your per share gain to your dividend income and then dividing it by the original cost to arrive at the returns. For instance, imagine that you buy a share for Rs. 60, hold it for a year, and receive a dividend of Rs. 10 over this period. At the end of the year, you sell it for Rs. 80, realising a gain of Rs. 20 per share. Therefore, your return rate would be Rs. 10+ Rs. 20, divided by Rs. 60*100, which is 50%.
Bonds – You can calculate returns on bonds by adding the premium earned during its sale to the interest income gained while holding the bond. Divide it by the cost at which you bought the bond to arrive at the rate of return.
Now that you know the answer to the question of how much does the average investment make, remember that a variety of factors like your investment behaviour, economic growth, geopolitical aspects, interest rates, inflation, and tax rates can affect your real returns. However, the only way to earn returns is to invest, and the best way to earn high returns is to invest for a longer period of time, so start your investment journey right away!
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