Return – If it is Zero or Low or (Negative) What will happen (CAGR)?
are you looking to invest in real estate, mutual funds, or in the stock market for getting a return on investment (CAGR)?
I have seen many investors investing 100% of their savings into a single asset class like real estate or equity mutual funds.
In addition, they believe that they will get a very good profit.
Here, I am not saying that you will not get a profit.
We can measure the profit by calculating the CAGR in our investment.
But do remember there is no real CAGR in the real estate and in the stock market.
In addition, to understand why there is no CAGR in the real estate and the stock market, read this article.
Let’s understand What will happen to your return in case of zero or low or native ROI?…
If you have invested Rs.1,00,000 in an Asset class ( real estate or equity mutual funds or stock market) for 15 years term, and the average CAGR is 12%.
But do remember, this CAGR is not a real compounding one.
In addition, for simplicity purposes we express our return on investment ( profit) in terms of CAGR.
You can see in the above image Rs.1,00,000 became Rs.5,47,356 in 15 years, if the CAGR is 12% per year.
What will happen to your CAGR if you get a “zero” return from the 16th year to the 20th year?…
You can see in the above image that your investment value is the same in the 15th year to the 20th year.
In addition, this is due to “zero” profit or return on your investment from the 16th year to the 20th year.
Moreover, the CAGR for 15 years is 12%. But the CAGR after 20 years will not be 12%.
You can see in the above image that the CAGR is 9% after 20 years.
But the CAGR at the end of the 15th year is 12%.
So, it is very clear that your CAGR is decreased from 12% to 9%.
In addition, this is due to the “zero return” on your investment value from the 15th year to the 20th year.
Hence, it is evident that our CAGR will decrease if there is a “zero profit” or “zero return” on our investment.
What will happen to your profit (ROI) if you get a low return on your investment?…
You can see that in the above image that I took low-profit % from the 16th year to the 20th year.
In addition, the investment corpus at the end of the 20th year is Rs.6,65,942.
Here, also we can calculate the CAGR for 20 years.
In the above image, you can find that the average return is 10%.
In addition, the above profit of 10% is also low when compared to 15 years of profit of 12%.
What will be your CAGR if you get a negative profit % from year 16th to 20th year?…
You can see in the above image that I took native profit % from the 16th year to the 20th year.
As a result of this, the corpus from Rs.547,356, it became Rs.3,86,886.
You can see the CAGR in the above image after 20 years is 7%.
But it is 12% at the end of the 15th year.
So, it is very clear that your return on investment will be decreased if there is a negative profit % in any year.
In addition, do not argue that it will not happen in the long run in real estate or in the stock market.
Now, the coronavirus situation is going on in India.
In addition, the Indian stock market Index Sensex already corrected (fallen) nearly 30% from its high.
and Indian real estate is also corrected, but the numbers not yet came.
So, we understood in this article that our profit or return on investment will decrease if there is a “zero” or “low” or “Negative” return in a few years.
In order to prevent our return % to some extent, we have to follow some strategies.
What is the strategy to prevent our return on investment or Profit?…
The answer very simple, we should not invest 100% of our savings into a single asset class like real estate or equity mutual funds and the stock market.
In addition, we should diversify our investment in different classes based on our financial situation and risk tolerance and time horizon.
In above image, I have assumed that you have invested out of Rs.100, Rs.70 in equity, and Rs.30 in debt ( bank fd kind of asset class).
In addition, the return expected from the equity in an uptrend is 12%, and in debt is 6%.
If you invest in more than one asset, then it is called a portfolio.
The equity portion profit amount is Rs.8.4 and the debt portion profit amount is Rs.1.8 after 1 year.
In addition, the portfolio profit ( including equity and debt ) is Rs.10.2 after 1 year.
Here, you must have noticed that if you have invested 100% ( Rs.100), you could have made Rs.10.2 profit.
But we do not know after we invest in 100% ( Rs.100), the equity market will go up or down.
So, sometimes investing in a portfolio may give lesser returns than 100% equity or real estate investment.
You can see in the above image that I took equity return % as “-12%”.
Now, the portfolio return became “-6.6%”.
In addition, if you have invested 100% ( Rs.100) in equity, your return on investment, Your return would have been “-12%”.
But as you have invested Rs.70 ( 70%) only in equity, your portfolio return in the above image is restricted to “-6.6%” only.
Finally, it is very clear that some times ( in an uptrend) Portfolio Investment may underperform.
But we know that investments always will not give you high profits, sometimes they may give you a “negative return” too.
So, it is the wisest thing to invest in a Portfolio and re-balance it at least once in a year.
What is re-balancing?, I will explain in another article.
Always remember that we should not try to hit all balls in the cricket for a sixer.
Playing defensively for some balls also necessary in cricket.
Similarly, we should not invest 100% in equity mutual funds or real estate or in direct equity.