personal finance

How to estimate returns on equity investments


Tara is a systematic investor in equity funds. She earns well and is single. She takes the SIP route to invest regularly.

While she does not have any specific financial goals, she wants to ensure that her money is growing well. However, she is concerned about the returns on her investments and wants to know how she can evaluate her investments.



First, Tara should know that returns from investments occur only in the future and therefore can only be estimated. There is also no guarantee in the investment world. If she wants to protect her investments, her focus should be on the processes she follows while choosing the equity funds, the time points at which she invests, and the period for which she invests.

How can Tara estimate the returns? The easiest thing to do would be to look at the historical returns and form some expectations on that basis. It is also important to understand how returns on equity are made. The ability of equity to earn a higher return comes from businesses being able to use borrowed funds, invest them in assets and earn a return that is higher.

Growth in businesses is reflected in the country’s GDP growth. So if India’s GDP is likely to grow at 7-8% and the inflation is in the 6-7% range, then the country’s GDP in nominal terms may grow at 14-15%. Tara will find that in the Indian context, the average long-term returns from equity have been about 14-16% and the future estimates are similar. This will come down if the inflation or GDP growth fall in the future. The business risk is compensated by the risk premium on equity investments.

This also explains how long-term returns from equity investments tend to beat the inflation numbers. Tara should not expect to earn a steady return every year, but expect the ups and downs, which tend to average out overtime. If she diversifies her investment so that she holds a basket of equity shares, invests consistently and ensures that she stays for the long-term across market cycles, the return is likely to be close to the long-term average. Since her investment process is designed to reduce her risks, she should do well, given her long-term orientation.

(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)





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