A compass does not tell you the exact path to your destination, but it keeps you oriented as the terrain changes. Market benchmarks serve a similar purpose for investors. Following the BSE Sensex gives a sense of where large Indian companies are heading, while the many gauges within BSE Indices cover sectors, sizes and themes. When used sensibly, they help you measure progress, set realistic expectations and stay disciplined over the long journey of wealth creation.
Table of Contents
Defining Your Goals First
Before choosing anything, clarify for yourself what you are investing for. Retirement, a child’s education, a house and a sabbatical need different time horizons and amounts. So write them down with approximate sums and target dates
After you have done that, figure out how much you need to invest every month to meet each goal. A simplistic calculation based on your assumed annual returns would show you the corpus that you can accumulate. You should be cautious here and not too optimistic since historical data on long-term equity returns in India has been all over the place. Past performance is no indicator of future returns, and planning around a lower number will prevent you from being disappointed later
Choosing the Right Yardstick
A yardstick only makes sense if you have invested in something comparable. If you have mostly large-cap stocks, the thirty large-cap stock index or the overall large-cap index is a good comparator. Similarly, if you have mid-cap stocks, a mid-cap index is a better yardstick. Comparing apples to oranges is not a good way to calculate returns on your stock portfolio. Large-cap funds should be compared against large-cap indices, while small-cap funds should be measured against small-cap indices
When it comes to mutual funds, check their fact sheet for the benchmark they use. It is a good idea to compare the returns of a fund against its benchmark. However, do not look at one-year returns; look at three, five, and ten years. For funds that have consistently underperformed their benchmark despite a low expense ratio, consider switching to a passive fund that tracks the same benchmark
Measuring Real Progress
While comparing absolute returns, it is a good idea to look at total returns, especially if you are investing for the long-term. Many indices carry the dividend-paying capability of the stocks in their calculation, which shows you the real-life returns one can expect by holding on to the stock/index
Another good way to look at returns is in real terms. If inflation is, say, 5-6%, a 10% return can only give you 4-5% returns in terms of buying power. Since everything is going to be in future rupees, it is a good idea to calculate your returns in real terms. You should also adjust your goals according to future inflation, especially if you are saving for education and medical expenses
Asset Allocation: The Larger Question
Research and experience have shown that the asset allocation, or how much you put in different asset classes like equities, debt, gold, and real-estate, determines your success more than the individual picks you make in the stock/bond. While the yardsticks discussed above tell you how much to allocate to equities, the rest will depend on your age, income, and risk tolerance. A thumb rule is to put 100 minus your age in % in equities. However, you must decide for yourself based on your financial situation. Someone with a stable income can put more into equities as compared to someone with a month-to-month salary. Likewise, if you are nearing your goal, you should reduce the amount you put in risk assets like equity and gold to preserve your capital. You do not want to empty your retirement corpus just because you are down 20% in gold
Rebalancing and Review
Review your portfolio at least once a year and rebalance it if necessary. If equities have gone up, it means they now form a bigger chunk of your portfolio, so sell some and buy more in the asset class/category that has less weight. Similarly, if the weight of equities has decreased, it is a good time to buy more equities. In this way, you are selling high and buying low. Some systematic way of rebalancing, like the one mentioned above, will help you stay disciplined and not time the market. When you review your portfolio, you can also check if your personal situation/surroundings have changed. Getting married/promoted/financially secure can change your goals. Change your allocation based on these changes. It is also a good idea to increase your savings rate every year if your income has increased
Habits That Make You Richer
Set up systematic investment plans that can take money away from your salary before you spend it. Keep costs low by investing in direct plans or low-cost mutual funds. And do not fall prey to speculation and hot tips; invest based on financial logic. Invest in good companies based on their financials, valuation, and your own financial needs
Do not risk your corpus by not having proper health and/or term life insurance. Cover all your risks so that in case of an emergency, you do not have to sell off investments at a loss. Maintain an emergency reserve fund apart from your goal-specific investments
The Journey Ahead
Wealth creation is a slow, almost boring process. It requires you to keep investing regularly, stay invested for long, and most importantly, remain disciplined during volatile times. Benchmarks are what keep you honest so that you do not overreach or get too scared. Use them to your advantage and let them do the talking on your behalf as you follow the process outlined above