We all are always very conservative and careful with our capital and why not it is our hard earned money. Very few of us (less than 2% of Populations) come to stock markets and the sole aim remains ‘to get better returns’. Talking about returns, we were always imbibed with the thought of saving money for future and that is one of the reason why India’s large amount of earnings goes into savings. The fixed deposits always remained the preferred choice because of three reasons (1) Safety of capital with nationalized banks (2)reasonable returns coming as interest on capital and (3) certainty of returns in all economic cycles. In contrast, the stock markets was always known for their volatility, losses due to volatility and most important scams. This kind of scenario always project stock markets as risky way of investing and people seeking better or I would say extraordinary returns only turn their face towards this side.
So the question comes, whether it is safe to invest in stocks and what kind of returns can one expect while investing in stock markets. To answer this question, we should understand in little detail about it where we are evaluating to put our hard earned money.
Stock Markets and Shares
Stock Markets are the place where companies find equity participation for their businesses. Entrepreneurs, trying to open large size ventures require bigger capital. The only way to source such capital is through debt or loans from banks, financial institutions, other companies or individuals. The other way is to get more partners who will put in money to start or run a business and in return will share profits/losses. These equity participations are divided into equal value of small units called shares. Such shares are issued in IPOs and subsequently bought and sold in open markets i.e stock markets.
Our investments in markets provides a returns in two forms first being the dividend and other being the increase in value of company or shares. The expectations in terms of returns, comes with a factor of time horizon and risk associated with stock. The expectations on returns may be compared with climbing a mountain, the steeper it is , the more risk it involves. People play around with various strategies like buying and holding share for longer durations, short term buying selling, future and options trading, intraday trading, etc. Ultimately these strategies are the factor of return expectations and risk appetite or the investor or trader.
How to expect returns
Before discussing return expectations, we must dig out from our memories, the first and foremost statement of investing.
“Returns are directly proportional to risk”
Normally all books or journals we read always talk about a number or expected rate of return. These numbers are generally provided but none provides the formula to ascertain returns. What I witnessed, a common way adopted by some of the successful investors and traders is based on following factors
|The corpus size or the amount of investment||High||Low|
|Investible amount as the percentage of total networth of investor||High||Low|
|Period for which the amount needs to be invested||High||High|
|Bank FD rate (pre tax or post tax)||High||High|
|Tentative losses if the situation is not favourable||High||High|
|Liquidity available for exit||High||Low|
Apart from these factors, market movement is also an important indicator and used by most fund houses as barometer. The returns in the markets can be measured on periodical basis by the way of indices like Nifty, Sensex, Bank nifty, etc. Any strategy which beats the market returns on monthly, quarterly and annual basis are treated as good. However such market returns are always compared with fixed income bearing securities like fixed deposits etc. Fixed deposit rates of banks ranges between 6 – 9% however NCDs or corporate fixed deposit yield somewhere between 10 – 12% so obvious expectation from buying shares should be beyond these rates. Where corporate FDs comes with a default risk however in shares both price risk also gets added.
Traders generally talks about very high return expectations however it is important to note that in trading one also need to take care of his own cost or opportunity cost of his own time deployed. Thus the return should be calculated after deducting these costs.
One must understand that while investing in stocks, he is practically investing into a business which may or may not perform. This performance clubbed with market sentiment as a whole are going to impact the returns. The companies are normally evaluated for their current financials, business stature, expected growth and quality of management however objective evaluation is just the price of their stock. Traders generally expects a far higher returns, also because of their own time devotion. The trade strategies often meet stoplosses which are more derived from the stock movement however the quantity of stocks are governed by the margin or trade capital.
Although expected rate of return are very individualistic decision however its factors should be carefully evaluated before entering markets. Also maintaining a record and evaluation will help in far better decision making and evolving the methodology.