Equities as an asset class are risky in nature; which is why one expects higher returns - as compared to relatively safe instruments such as bonds and fixed deposits - from them. But then, what should be the ideal return that one should target? One may hear multiple responses to such a question. Some of which include capital doubling every year, every three years, every five years, etc.
At the end of the day, one needs to be realistic about the same.
Over the years, many models and tools have been derived which the investing community uses to come up with answers to the question - what returns one should expect from equities.
Given the riskiness of equities, what these tools essentially try to arrive at is the additional premium that equities need to compensate for their riskiness and volatility. All this is in comparison to a safe asset class such as along term government bond. To calculate such premiums, many factors need to be taken into consideration depending on the model used. These include assumptions on GDP growth, target inflation, expected yield on indices, earnings growth forecast, amongst others. In short, a good number of assumptions are to be taken just to arrive at this figure of risk premium. Broad calculations on these can give results varying from 8% to 20%. More so, as one keeps tweaking such assumptions, the number could move higher.
Since there are complications behind each factor - which in itself require many assumptions, we believe one can keep things simple by calculating the compounded returns the benchmark index, BSE-Sensex. This needs to be done over a long period. For instance, the index has returned 14.2% on a compounded basis for more than two decades. As the index represents the top blue chip safe stocks in the entire stock universe, we believe this would be a good figure for expected return target.
One thing that needs to be kept in mind here is that the above calculation takes into consideration the historical data. Having said that, the same is calculated over a very long term period thereby taking into account the many cycles and volatility that the market has witnessed over the years.
At the end of the day, one needs to be realistic about the same.
Over the years, many models and tools have been derived which the investing community uses to come up with answers to the question - what returns one should expect from equities.
Given the riskiness of equities, what these tools essentially try to arrive at is the additional premium that equities need to compensate for their riskiness and volatility. All this is in comparison to a safe asset class such as along term government bond. To calculate such premiums, many factors need to be taken into consideration depending on the model used. These include assumptions on GDP growth, target inflation, expected yield on indices, earnings growth forecast, amongst others. In short, a good number of assumptions are to be taken just to arrive at this figure of risk premium. Broad calculations on these can give results varying from 8% to 20%. More so, as one keeps tweaking such assumptions, the number could move higher.
Since there are complications behind each factor - which in itself require many assumptions, we believe one can keep things simple by calculating the compounded returns the benchmark index, BSE-Sensex. This needs to be done over a long period. For instance, the index has returned 14.2% on a compounded basis for more than two decades. As the index represents the top blue chip safe stocks in the entire stock universe, we believe this would be a good figure for expected return target.
One thing that needs to be kept in mind here is that the above calculation takes into consideration the historical data. Having said that, the same is calculated over a very long term period thereby taking into account the many cycles and volatility that the market has witnessed over the years.
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