Walk into any corporate cafeteria or join a family gathering, and the conversation eventually drifts to money. The question of the hour is usually a simple one: “What's the best performing mutual fund right now?” or “Is now a good time to invest in the stock market?” These questions are both commonly asked yet represent a misguided approach for Indian investors.
The Indian investor's psyche has always been ruled by the single obsession of maximizing returns. We view investing as a race in which our sole objective is to run faster. But this is a fundamentally flawed philosophy that inevitably sets us on a vicious cycle of anxiety, lousy decisions, and financial disappointment.
True financial well-being doesn't start by asking what the market can give you. It starts by calculating what you need to get. It begins with the Required Rate of Return.
The problem with chasing the market
When you create a financial plan that is dependent upon market return expectations, you are essentially creating a home without a solid foundation. You may look at the Nifty 50 or small-cap index and see a 20% annual gain and think to yourself, “If I invest now, I too will receive a similar gain.”
The trap in this approach is hidden. In your quest to get the best possible return, you were led to an unintentional acceptance of the highest possible risk, regardless of whether this is suitable for you or not. You are enslaved by the mood of the market. You are willing to drive at over 100 km/h just because the car can go that fast, not because you have to.
The “required return” Approach
“Required Rate of Return” is not market-linked; it is a personal one. It has nothing to do with what the Sensex did yesterday. Instead, the “Required Rate of Return” is based upon a simple, personalized equation that considers how much money you have saved at present, how much money you need to save to achieve your financial goals in the future, and how much time you have remaining to achieve these goals.
Consider a typical scenario. Assume that you are saving for your child’s higher education, which you estimate will cost ₹50 lakh (adjusted for inflation) in 15 years. You currently have ₹5 lakh invested and can save ₹15,000 a month. If you do the math, you might find that to achieve that ₹50 lakh target, your portfolio needs to grow at a compound annual growth rate (CAGR) of approximately 10% to 11%.
This number 11% should be your focus. It changes your whole relationship with the market.
Knowing you need just 11% to fulfil your life's promise to your child eliminates the pressure to pursue risky micro-cap stocks or the volatile sector fund that promises a 20-30% return. You can afford to ignore the noise and construct a boring, balanced portfolio of equity and debt aimed at that 11% with much lower volatility. You stop trying to beat the market and start paying attention to meeting your goal.
The difference between these two approaches, market-first versus goal-first, is starkly visible when you look at how investors behave during a crisis.
The investor who bases their strategy on past market returns is always in chaos. Their big question is always about performance compared with someone else. “My neighbour’s fund is up 30%, why is mine only up 15%?” Because their strategy is based on getting the “maximum”, they take on maximum risk. When the inevitable market correction happens, the investor panics. They see their wealth eroding, they have no anchor to hold onto, and they often sell at the bottom to stop the pain.
The investor who focuses on the Required Return has a calm sense of assurance. Their biggest question is a personal one: “Is my portfolio still on track to meet my goal?” Since they calculated their required return in the first place, they will probably only take as much risk as necessary. They didn't need to buy the riskiest assets, so they didn't.
When the stock market experiences a correction, investors do not panic because they focus on their long-term average returns. If their required return is 12% and they are currently sitting on 14%, they know they have a buffer. They could even see the market fall as an opportunity to rebalance and not run away. They are not trying to beat the benchmark index; they are trying to buy a house, fund a wedding or secure a retirement. As long as those goals are on track, the daily volatility of the Sensex is irrelevant.
The “speed limit” for your wealth
Think of the Required Rate of Return as a kind of speed governor on a vehicle. The current Indian economic landscape is filled with a huge influx of retail investors. Systematic Investment Plan (SIP) books are at all-time highs. But many of these new investors have seen only one type of market: a bull market. They are conditioned to expect 15%, 20%, or even 30% returns because that is what the recent past has delivered. This is dangerous. When you don't know your required return, you don't know when to say “enough”.
If your financial plan dictates that you need a 12% return to retire comfortably, and a bull market pushes your portfolio returns to 18% for the year, the goal-based investor recognizes this as a signal. It is a sign that they have engaged in “excess speed”. It is a cue to book profits and move that excess money into safer assets like debt or fixed deposits to lock in the victory.
Whereas, the market chaser looks at that same 18%, gets greedy, and thinks that it will go to 25%; they double down at the peak.
The financial planning in India needs to move away from being product-centric to problem-centric. We invest too much time in analyzing the features of financial products and not as much in analyzing the features of our own lives.
The next time you sit down with your adviser or open your investment app, resist the urge to start searching for the “top-rated” funds. Instead, work backwards: Define the goal. Calculate the cost. Determine the timeline. Once you know your Required Rate of Return, investing will be less about gambling and more about engineering. It will be boring, predictable, and effective, and when it comes to your life savings, boring is exactly what you should be shooting for.
Prasenjit Paul is an equity analyst at Paul Asset and the fund manager of 129 Wealth Fund, a Sebi-registered Category III Alternative Investment Fund. He is also the author of two bestselling books: How to Avoid Loss & Earn Consistently in the Stock Market and Multibagger Stocks.