Read to know how you can earn 15% annual returns on your investments

In this article, we describe an approach as to how investors can build a portfolio to achieve their target returns. But if you are really impatient, you can directly jump to the section on ‘The 15% returns portfolio’. However remember that no advice is suitable for every investor, so do definitely read our ‘Should everyone buy this portfolio’ section on how this portfolio may or may not be appropriate for you.

To earn returns you need to take the risk. Period.

So you are looking to earn a certain return – say 15% per annum – on your investment? The first number that you should consider is the risk-free rate (loosely interpretable as the rate you earn on bank deposits) in the country. In India, the risk-free rate (as set by the RBI) is ~7%. In the US, it is currently close to 0%. Why is this important? Because if you are looking to earn anything above the risk-free rate you need to be prepared to take some sort of risk. If you are looking to earn 15% per annum in the US, be prepared to take an insane amount of risk. In India, thankfully the task is easier.
Now that we have established that you need to take some amount of risk over an above a simple bank deposit, the question is what kind of risk to take. We list below a (hopefully) comprehensive set of things you can do, in the order of least risky to most risky.

1. Interest rate risk: You can choose to lend out your money for a longer period of time than in bank deposits. This can be done in a number of ways –  long-term FDs, small saving schemes such as PPF, NSC, Sukanya Samriddhi etc.  However, one issue with these schemes is that you are actually locked in for the period of time for which you are investing your money. Investors can withdraw early but with penalties. One way to lend money for the long-term while retaining the option to exit early is by investing in instruments where a secondary market exists such as 10yr government bonds. With 10-year government bonds, for instance, you can earn the current 10-year interest rate but in case you need your investment amount before 10 years you can get that by selling the bonds to somebody else.  You can either invest in long-term government bonds directly or through debt mutual funds which invest in these securities.
2. Credit Risk: With government bonds, you lend to the government which is the highest credit in the country. But you can also choose to invest to lower credit investors like corporates and increase your yield. The increase in yields that you get is directly linked to the credit quality of the issuer. For instance, PSUs are usually considered low credit risk because they are seen to be in some sense backed by the government. Hence the increase in yield that you will get by investing in PSU debt over government debt will be low. You can get a greater yield pick-up by investing in riskier corporates. The credit rating of an issuer is an indication of its credit quality/probability of default. Investors can take credit risk by investing in corporate FDs, corporate bonds etc.  Or they can simply invest in mutual funds which invest in these securities.
3. Market risk: By market risk, we mean Equity market risk. Equity markets are a proxy for a lot of things – GDP growth, low and stable inflation, stable political situation, reasonable current account deficits and just a general sense of well being. You can take the risk that good times will continue and further increase your returns by investing in equity markets. There are so many ways of investing in equity markets that it deserves a blog post but in very short, investors can invest either in the entire equity market or some segment of it like large cap, mid cap or small cap or in certain sectors such as banking, IT etc.  Large-cap stocks or stocks of big companies are generally considered to be less risky. Smaller cap stocks are considered riskier. Further diversified equity exposure is considered to be less risky while going for a concentrated portfolio either by investing in a few sectors or just a few stocks is riskier. As you would have guessed by now, more risk also equals the potential for higher returns.  Further in each of these areas, investors can either invest through mutual funds which focus in that area or but shares directly themselves. However unless and until the investor is being really selective about the stocks they want to buy, investing in funds is probably easier.

In addition to each of these risks, you can decide to go to public markets. Or you can take additional illiquidity risk (the risk that you will not be able to withdraw your money at any time) and lend to local businesses, invest in private equity etc. This can increase your yield further.
Finally, apart from financial assets investors can also invest in real assets such as real estate and gold. In general, these do better (worse) than financial assets when inflation is rising (falling).

Diversify. Diversify. Diversify.

The 15% returns portfolio

According to us, the following target allocation is a less risky way of getting 15% returns every year. Given the relatively high return target, there is no allocation to short-term debt such as in the money markets.

If we assume that we invest in this portfolio through index mutual funds (and deduct a representative expense ratio), then this is how the returns in the past years would have looked like (2016 returns only include returns till the end of August). As you can see investing is still risky and there is a lot of variation that you find around the 15% level.  In its worst year (2008) the portfolio was down nearly -21%.  Anybody looking for 15% returns should make sure that they are comfortable with this kind of variation before they invest.

For investors looking for a different target return, they can see similar asset allocation and annual returns for their return choice here.
We have picked mutual funds for investing in this portfolio because they are convenient and applicable for most investors. They allow for easy entry and exit. With mutual funds, investors can gain access to the whole diversified portfolio even with a small investment amount – something which is not possible if investors try to build a diversified portfolio by buying equity shares themselves.  Further, it is equally valid for large investors because there is no upper cap on investment, unlike small saving schemes. These were also the reasons for preferring gold over real estate as the real asset in this portfolio.

Also, we have chosen index mutual funds (which just track a benchmark index) to show that these returns without even doing fund selection. Investors can, of course, do one better by making the right fund choices. But as you would probably expect by now, that comes with the risk of not doing as well if your fund choice was wrong. At ORO, we have a list of funds which we think are likely to outperform in their categories. You can check that list here.

Finally, these returns are also assuming that you invest in 0-commission direct plans with a provider like Orowealth (Access our investment platform). If you buy regular plans, then deduct ~ 1% from your returns every year which will go to pay commissions.

Should everyone buy this portfolio?