Portfolio Valuation: Real And Notional

Hemant Rustagi
Chief Executive Officer, Wiseinvest Advisors 

Investing is a process that requires you to choose the right mix of assets and investment options while also ensuring that investments remain on track to achieve your investment goals.Despite planning well, you may be faced with many challenges through your investment time horizon. Therefore, the level of success you achieve would depend on how efficiently you tackle these challenges. Fortunately, most of the challenges like volatility in returns and impact of economic and geopolitical factors on the portfolio can be tackled to a varying degree depending on how disciplined you remain during periods of market upheaval and how carefully you monitor your portfolio.

However, one factor that impacts the performance of the portfolio at all times but is seldom given its due is the ‘real rate of return’ i.e. gross returns minus inflation, taxes and costs. Usually investors focus on ‘gross returns’ and make that the basis of their investment decisions. No wonder, traditional instruments like fixed deposits, small savings schemes and bonds or debentures continue to be the mainstay of portfolios of a large section of investing public in our country. Although these instruments provide guaranteed returns, their returns are low and they are tax-inefficient. Needless to say, the real rate of returns is either bare minimum or negative at times.

As is evident, apart from choosing the right investment options, it is absolutely necessary to consider factors such as inflation, taxes and costs to improve the real rate of return. Remember, when your investments fail to beat inflation, your money grows only in numbers and not in value. Let us analyse how these factors impact your returns and how you can minimise their impact on your portfolio.

Inflation

Inflation reduces the value of your investment returns over time. While inflation affects all aspects of our lives, the most challenging aspect is to keep up with the rate of inflation in order to protect the value of your investment as well as returns earned on it. Of course, the impact of inflation on your portfolio would depend upon its composition. One of the asset classes that have the potential to beat inflation over the longer term is equity.

However, investing in equities would mean taking higher risk as compared to some of the instruments that give predetermined or stable returns. Thankfully, there are strategies like systematic investing and remaining committed to your defined time horizon that can not only minimise the impact of volatility to a large extent but also improve your returns through averaging.

Tax Efficiency of Returns

Tax efficiency of returns on your investment portfolio plays a crucial role in improving the real rate of return in the long run. In fact, tax efficiency becomes even more important when you invest to achieve medium to long-term investment objectives like children’s education, buying a house and retirement planning. Investment options like mutual funds provide tax-efficient returns. For example, returns from an investment held for 12 months or more in an equity fund are taxed at a flat rate of 10 per cent, without indexation. For investors in the higher tax bracket, it can make a significant difference to what they get to keep at the end of their investment process for a particular long-term goal. Therefore, following a ‘tax aware’ investment strategy can contribute significantly to earning positive real rate of return.

Costs

While costs are the most ignored aspect of investing, focusing too much on them can either make you compromise on returns or expose you to higher risks, taking you beyond your risktaking capacity. For example, investing in traditional investment options alone or investing directly into equity funds can reduce your cost but expose you to higher risk if you are not confident about making the right choices. Remember, since equities provide higher returns over time, the impact of costs may not be much on your portfolio if an investment is held for the longer term.