How to strike a balance between investment expectation and financial goal

Investors must manage their biases and decide what is the right size for each of their positions in a portfolio

One memorable lesson from my induction training in a company was that “expectation reduces joy”. In a professional setting, it’s crucial to manage expectations, particularly regarding salary hikes and promotions, as unrealistic expectations can lead to disappointment, decreased productivity and poor health.

At the same time, setting high but rational goals is important, not just professionally but also in personal relationships and investments.

As an investment adviser, managing client expectations is crucial. I often ask clients about their risk appetite and return expectations. Many have unrealistic expectations, such as doubling their investment in three years, which would require a compound annual growth rate (CAGR) of 25-26 per cent per annum. While not impossible, this is challenging to sustain for long, especially when investing in diversified mutual funds.

Expectations often rise during market booms, leading to aggressive investment behaviour. New investors, attracted by rising markets, underestimate risks, mistakenly believing that investing in stocks or equity funds guarantees high returns. Their lack of historical market knowledge or missing out on previous bull runs can further exacerbate unrealistic expectations.

These expectations can lead to disappointment and risky behaviour, such as shifting to less regulated products. Investors must understand that market behaviour won’t change based on their investments: Equities will remain volatile and debt investments will generally be more stable.

It is common to hear people desiring to start trading or investing directly in stocks during bull markets. While potentially lucrative, stock trading requires extensive research and discipline. Unlike mutual funds, where the risk of total loss is low, the price of a stock can go to zero. Individual stocks carry higher emotional and financial risks. Investors must have the ability to manage their biases, and they must have the ability to decide the right size for each of their positions in a portfolio.

Unrealistic expectations can lead to overinvestment, risky decisions, and stress, while compromising investment discipline. It can also lead to investors focusing too much on returns rather than on their financial goals.

To manage expectations, investors should:

• Realise that they cannot control returns but can control how much they invest. Lower return expectations can lead to increased investments, which can in turn help them reach their financial goals sooner.

• Understand the difference between investment return and investor return. While many funds and stocks have given high returns over decades, few investors have managed to stick to them for that long to actually reap the gains. Historical success stories, like early investments in major companies, highlight the importance of having a long investment horizon in equities.

• Recognise that equity markets always carry risks, and while long-term investments can reduce these risks, there’s no guarantee of success.

• During the accumulation phase, volatility can be advantageous, helping investors earn better returns through rupee cost averaging (systematic investment plans or SIPs).

• However, during the decumulation phase, such as retirement, volatility can be detrimental, exposing investors to sequence-of-return risk.

(The writer is a Sebi-Registered Investment Advisor)