The benchmark Nifty 50 index has given almost no return in the past 12 months. Nifty Smallcap 100 Index is down over 13% and Nifty Midcap 100 index is down about 2.5% over the same period. Adjusted for dividends and inflation, the real returns would be worse. On a comparable basis, the benchmark S&P 500 index of US yielded a negative return of ~15%; Stoxx500 of benchmark index for Euro Area returned negative 12% and Hang Seng, benchmark for Hong Kong market, returned a negative yield of ~30% over the same period.
This is a popular set of statistics that is used by market participants like advisors, portfolio managers, and wealth managers etc., to advance arguments in support of their past performance and future prospects of investments made now.
Investors use this set of statistics in a variety of ways. For example—
· Investors following a relative return strategy may find comfort in the fact that their portfolios have performed better than the benchmark indices, though they have lost money or earned a negative return on their investments.
· Investors who are invested for a long term, may argue that Nifty 50 3yr CAGR is still 15.5%, which is a decent real return of over 10% p.a., accounting for inflation and dividends.
· Some investors may draw comfort from relative outperformance of Indian benchmark indices, as compared to the global peers; even though their own portfolios have yielded negative returns.
In my view, however, this could be a serious mistake most of the investors might be making. The relative return argument (or “strategy” if you prefer to use this jargon) serves no purpose for those investors who are depending on their portfolio of financial investments to meet key goals of their life, e.g., financial freedom and retirement planning etc. To the contrary, this argument could actually lead them to a false sense of security and comfort; whereas their primary objective of investment might be getting defeated.
The investors whose investment objective involves any one or more of the following ought to prefer an absolute return strategy, instead of a relative return argument. For their investment objective would invariably involve a defined cash flow over a definite period of time.
1. Retirement planning – regular income to supplement the loss of salary/wages.
2. Goal based investment, e.g., buying a house, children education expense.
3. Financial freedom - assured minimum income to allow
Such investors should ignore the noise and resist excitement in their investment endeavors. Their investment strategy must focus on making a reasonable rate of absolute return over the “defined” period of time. Beating the benchmark index should be the least of their concerns.
However, the investors whose investment objective is primarily wealth preservation and/or reasonable growth; and regular cash flows from investment are not required to sustain (or improve) their lifestyle may accept a relative return argument; for historically the benchmark indices have been able to yield decent positive real return. These investors can afford to bear intermittent volatility since they do not need regular cash flows or lump sum redemptions at defined intervals.
