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Are you Investing without Understanding ‘Real Returns’ ?




Are you Investing without Understanding ‘Real Returns’ ?

 

Mr. Barot works as a middle executive in accounts department of a Large Corporate. He is 53. He came to my contact after my financial literacy workshop at his company. On conducting his Personal Finance Health Checkup, I found that majority of his investments are in Insurance and on probing further he has saved and invested almost 30-40% of his income throughout his career. His primary reason for investing into insurance was to get tax benefits and he was guided by one of his relative who happens to be an insurance agent.
Financial health checkup revealed that despite of a regular saver and investor, his accumulated funds are short of his retirement corpus requirement and he still has his children’s marriages to be financed.
Personal Finance Issues of above client family are ; They have saved and invested regularly but still not able to meet their financial goals. Reason for the same is they didn’t understand real Returns Vs. Investment Returns.
Now let us understand what is Real Returns ;
There are two enemies of Investment Returns; 1) Taxes on your investments Returns and 2) Inflation. So while planning your investments, you need to consider effect of both tax and Inflation on your Investment Returns.
Mr. Barot considered tax while he invested but couldn’t consider effect of Inflation, due to lack of financial literacy, on his investment returns. Insurance policy typically give bonuses in the range of 40 to 60 Rupees per thousand of sum assured per year. Which is 4 to 6% returns. If we consider last 20 years average inflation, its 7 to 7.5%. So if we deduct inflation from returns, his returns are 6%-7.5% = -1.5% which is real return of Mr. Barot’s Investments into Insurance.
The formula for “Real Return’ is Investment Retun-Tax-Inflation Rate = Real Returns. So whenever you plan for your investments you will have to consider real returns and not nominal returns i.e investment returns.
The Effect ;
The effect of your failure to consider real returns could be ;
1. Your Investment Returns shall fall short of Inflation
2. The price/Corpus required for you goal would shoot up because of inflation but your investment returns delivering less returns, your accumulated corpus shall be less than required corpus at your future goal date.
 
Why Such Mistake Happen ; 
The root cause of this mistake is basically investor look of safe returns such as bank FD etc. Risk of Investments is to loose your capital. Loosing a capital and loosing purchase power of your capital cause almost equal effects. If investor opt for only safe investments giving negative real returns, he would loose purchasing power of his capital and would fall short of funds while achieving her financial goals.
How to save from becoming victim of such mistake ;
While planning for investments you need to balance between risk and Returns. You can plan for a balanced portfolio that also delivers your required returns and also assumes risk that is most suitable to your risk appetite. If you need help in planning your personal finance, you can consult SEBI registered Fee based Financial Advisor who are not only qualified and licensed to provide financial and Investment advise but are obliged to assume fiduciary role i.e Putting your ( Clients) interest Ahead of Self Interest.

 




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