Most people wish to maximize return on their investments. It’s a very common question that most investors ask. How much return can I expect?
When it comes to maximizing returns, there is only one secret sauce to wealth creation – (i.e.- Power of Compounding). We have learnt this in School.
A = P*(1+r)^n
Unfortunately, most of us focus on only one side of the picture (i.e.- r – return), while ignoring the other side (i.e. – n – time of investment). In reality, maximum wealth creation is not because of “r – return” alone but because of “n – the time period of your investments”.
It is time that plays a more crucial role in wealth creation, if we can optimize “r” and “n”, then no one can stop us from this.
This formula teaches us few very important things:
● A= 1*(1+1%)^365 = 37.78
Rupee 1 compounded over a long-term period resulted in growing to Rupees 37.78 (almost 38 times)
● A=1*(1-0.01%)^365= 0.9642
Even if incur a very marginal negative return of 0.01% and the mistake gets repeated, Rupee 1 reduces its principal value to Rs. 0.96 and will be less even after a long-term period.
There are two learnings here:
1. Power of Compounding works like magic over a long-term period.
2. We should not lose money; hence we should not experiment with the money.
While positive returns compounded create wealth, losing your hard-earned money can be fatal if it happens regularly.
How do we compound the money and not lose the principal amount as well?
Most people are aware that Power of Compounding works very well over a long-term period. However, very few know that it does not effectively & efficiently work for a time horizon of less than 5 years.
How do we optimize investment returns and mitigate the risk of investments?
In order to optimize investment returns and mitigate the risk of investment is easy as one can invest either via Equity Mutual Fund or simply invest in Exchange Traded Fund (ETF). Equity Mutual Funds or the Equity Markets have generated maximum returns as an asset class.
However, investing in Equity comes with the risk of volatility. The up & down of the market makes people nervous about investing. The risk of investing in an Equity Mutual Fund or Equity Index reduces with increasing time horizons. Historically the equity market over a long-time of 10 years, even on a rolling basis has not destroyed capital. It has created wealth. Make volatility your friend, ride the volatility, fewer, and then watch your investments multiply.
Investing in Equity Mutual Fund or ETF for a shorter period can be quite risky. There is a 60% probability of making money while investing in an Equity Mutual Fund for a time horizon of 1 year; the probability increases to 78% for a time horizon of 3 years and 85% for a time horizon of 5 years. Please note that this statistic applies to the overall index/ equity funds and not to individual stocks. Individual stocks face mortality over a long time as well. Hence, beginners must refrain from experimenting with their hard-earned money.
Goal-based investing works best
Hence it makes sense to segregate your short-term (less than 5 years) and long-term goals (more than 5 years).
Pick the most appropriate investment product that best suits your goals. Following this simple process will help create a huge amount of wealth.
Financial Advisors like Fincart suggest that if you have secured your financial status and are prepared for future and emergencies you can take risks. Risk-taking ability creates unlimited situations that can be approached for maximum investment returns. You can build your investment portfolios in your choice of investment solely for good returns.