Analysing the poll

I recently conducted the following poll on the blog. The results of the poll for the 205 responses are given below

What do you expect to make from investing in stocks in a 3-5 yr time frame?
10-15% per annum – 16%
15-20% per annum – 33%
20-25% per annum – 25%
25-30% per annum – 9 %
30%+ per annum – 14%

What was the idea behind the poll?
I had the poll for two main reasons. The first reason was to gauge the return expectations of the readers from stock market investing. The second reason was to discuss what I think would be required to get these returns

Comparing against market returns
The above return expectations are for a portfolio and hence it makes sense to compare it with index returns which serves as a benchmark. Why consider index returns? Well, it’s a passive form of investing. You can invest in the index and go to sleep and still make these returns. So one can call the index returns as zero effort (not zero risk) returns.

So what can one expect from the index? One cannot predict where the index will be in 3-5 years (though there are more forecasters than we need), but one can try to make an intelligent guess. The index is currently at a PE of 23 which is fairly above average. The index EPS has grown at an average of 14% for the last 17 years with 20%+ growth in some years and negative in others.

For the sake of argument let’s assume that the EPS growth will be 14% for the next 3-5 years and lets also assume the PE will remain the same (though I will not really bet on it). If one makes these simplifying assumptions, then the index returns would be 14%. If the EPS growth is higher or PE increases further, then the returns could be higher. On the other hand if the EPS growth is slower or PE contracts, then the index returns will be less than 14%.

So in conclusion one can say that the index returns are likely to be in the first option of the poll. By the way, almost 86% of those who participated expect to beat the market by a decent amount :). High expectations indeed!!

First option: 10-15% per annum
This is an easy one to achieve as long one does not try to get too clever. One needs to create an SIP (systematic investment plan) in an index fund or ETF and put a fixed amount of money into the fund every month. The SIP should give a return of 1-2% in excess of the index (due to cost averaging). So if one were to follow this plan, these returns are quite achievable.

Second option: 15-20% per annum
This was my choice of expected returns . This choice means that index investing alone will not help. If the index were to return 14% or so (which is not destined to happen), then achieving these kind of returns would require a combination of the following
– An ability to pick high quality companies at slight undervaluation. These companies have to do well to give the 15-20% returns for the next 3-5 years
– An opportunistic pick of a few companies which are in temporary distress. If one is able to identify such companies and buy them before a turnaround, then you can add a few extra percentage point returns.
So this option looks doable, but would require more than average, but not extraordinary effort to achieve it. A reasonably diversified portfolio of 12-15 stocks should help one to achieve these kind of returns

Third option: 20-25% per annum
Now we are getting into an interesting area. A 20-25% return means one would be able to triple his or her money during this period. At the current PE levels and an optimistic expectation of 14% returns, getting 20-25% would require quite an effort. I can think of the following

– An ability to identify some out of favor stocks and being able to bet heavily in a few of these ideas. For example if you think that sugar stocks are going to do well and are able to pick some cheap stocks before the turnaround and sell after the turnaround happens, then the returns are likely to be good.
– A core portfolio (50-60%) of high quality companies which will give above average (more than 14%) returns
This option is not a low risk, low effort option. It would require a decent amount of work to research underpriced stocks and bet heavily on them. I don’t think you can make these kinds of returns unless you have a decent amount of experience in stocks and can devote ample time to investing. Almost 25% of the poll participants think they will fall in this category of real superior investors

Fourth option – 25-30%
As expected only 9% of the participants selected this option. A 25-30% return means making 3-4 times your capital. If you have not made these kind of returns in the past for a 3-5 year period, then expecting such returns would be risky. One can make these kind of returns only if
– One picks undervalued picks, holds till they hit fair value and then sells them. In addition one will have to find such ideas consistently
– One will also have to be a bit lucky to make these kind of returns. A mid size to large market crash would certainly help. If the market were to crash, an investor should be able to commit a lot of money.
– A focused portfolio (less than 10 stocks) would be required with a decent turnover in the stock holdings.
– A small amount of portfolio will have to dedicated to options or arbitrage kind of ideas where one should be able to make 30%+ returns
These kind of returns are not easy to get, especially if investing is not your full time work. A lot of guts, some amount of luck and sufficient investing experience would be required to make these returns.

Fifth option: 30%+ returns
This option was voted by 14% of the participants. I can think of some reasons behind these fairly high numbers. Some of the participants voted for the sake of it without giving much thought or are getting delusional about the returns. One can expect these returns only if one is very new to the market and has no clue of what to expect or has been around for quite some time and is a superior investor

I really don’t have specific ideas of how one can achieve these kind of returns at low to moderate risk. One can make these kind returns only by being aggressive in the market and through a decent amount of leverage via options or otherwise. A 30%+ returns for the future would mean beating the market by more than 16-20%. These kind of high returns are not achievable by buying index stocks. One can make these returns by having a highly focused portfolio (3-4 stocks at best) of great ideas or by investing in other kind of instruments such as options.

The problem with such expectations is that unless one has made these kind of returns for some time, it is likely that the investor would take on high risk and could thus get wiped out. I hope these investors know what they are doing.

By the way – if you expect to make 25% or above, please share your thoughts via email or comments as I would really be interested in knowing how you plan to achieve these kind of results.

Why no negative returns
Someone mentioned in the comments on the absence of an option for below 0% returns. I think that is quite possible, but would be an uninteresting option. If one believes below 0% returns, then it is an easy decision. Put all your funds in cash or FD and get on with other things. A 0% or less return would mean a PE drop of almost 50% in the next 3-5 years.

An optimistic bunch
I have to say the participants of the poll are a very optimistic and confident bunch. I personally think a 15-20% would be a very good return for me and more likely to be around the 15% level than the 20% mark.

Final point: If you were expecting me to provide an 8 point or 10 point plan to achieve 15%+ returns and have voted for option higher than 15%, please re-think your expectations. If you need someone else to show you how to beat the market, then you could be in for an unpleasant surprise over the next 3-5 years.