What return will you get on your portfolio?

Ask this question to 100 investors, and if they are also investing in equity mutual funds their answer will vary from 14 to 24% depending on how smartly their IFA has convinced them about 19% + dividends as the historic Indian average. In fact I have met some IFAs who swear by 18% without including dividends.

Then I ask them how much will you get net of expenses and net of inflation. Now this gets them a little thinking, so they say well we should get about 12-13% p.a. because the headline inflation is about 7%.

Then I ask them how much will you get net of expenses – here they are SURE that the OUT PERFORMANCE by the fund manager will cover the expenses. Which means their mutual fund will get about 21% p.a. then you remove 2% for expenses. So the net return EXPECTED IS 21-2-7 = 12%.

If I were dealing with such an IFA and was willing to take a collateral from him, I would do a ‘full portfolio absolute return swap’. This means I would sell him my whole portfolio to him and take a 12% p.a. return swap – even if for just a period of 20 years, if he is not willing to do a 30 year swap.

THIS IS JUST FAR TOO MUCH FOR A PERSON DEPENDENT ON A FUND MANAGER AND IFA. 

So, in order to earn 13% for clients after inflation, fees and some taxes (STT, DDT, if not income tax), these financial planners will somehow have to pick investments that generate 19% or 22% a year before costs. Where will they find such huge gains? Since 1979, sensex has earned an annual average of 19.8%. The long-term, net-net-net return is likely to be under 4%. Assuming 2% for expenses, inflation of 12%, and 2% for taxes. All other assets like debt, real estate and gold earned  lesser. If, like all rational people, you have fixed deposits, ppf, epf, etc. your net is likely to be more like 2% OR EVEN LESSER depending on your asset allocation!!

The FOOLISH, AND impossible to believe faith in fancifully high returns is not just a harmless fairy tale. It leads many people to save too little, in fond hope that the markets will bail them out. It leaves others to chase  performance that JUST cannot last. The end result of such foolish and fairy-tale expectations, whether you are a DIY or with the help of an IFA, will be a huge shortfall and a big hole in wealth late in life, a short corpus, and more years working rather than retiring. Accountability to one’s thoughts and beliefs is very important – and I have done a post on portfolio accountability earlier.

I found many big IFA with nice big aum also having very high expectations. In fact most of them caught in an older mind set do not recommend debt funds in a big way. With declining trail in equity and rising trail in debt, the IFA should be revenue agnostic to asset class. I keep wondering whether it is just poor communication by the Amcs to the IFA. Sadly, mutual funds think raising the trail is an easier thing to do rather than improve communication with the IFA. As equity returns dip, they may be hit hard. However, the SIP boom is helping the IFA and the amc. One big IFA said ‘this number is just the starting point – none of us have any commitment to that number. No client calculates and comes back with ‘what happened’. Sad, is it not?

12%? I would swap a major portion of my portfolio for a TOTAL return swap at zero guarantee costs, but it has to come on the letter head of a company with about Rs. 1,000 cr. net worth.

For more alpha, I have my other direct equity portfolio, right?

 

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  1. For 20 year portfolio, 100% in Equities for 15 years. Shift to debt in last 5 years.

    Equity returns > inflation. No % figure. 100% in index fund at low cost. Dividends will take care of fund expenses.

    Net net = 15 year 100% equity so I get returns which is beating the inflation. & shift to debt for last 5 years.

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