Realistic Returns on the Stock Market: A Closer Look at Expected Gains

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Expecting consistently 15-20 percent returns from equities over the next 5-10 years might be setting your expectations too high. According to seasoned fund manager, Prashant Jain, a more realistic figure is around 12 percent. This estimate is based on comprehensive data and a deep understanding of market dynamics. Let's delve into the reasons behind this figure.

Why Should You Expect Around 12 Percent Returns from Equities?

For Prashant Jain, the mathematics are straightforward. Businesses and economies grow through two primary mechanisms:

Real growth (volume growth) Inflation

The nominal growth of a business is a combination of these two factors. Similarly, the economy works this way. Currently, the Indian economy is growing at approximately 7 percent in real terms, with inflation expected to be around 4-5 percent. The Reserve Bank of India (RBI) targets an inflation rate of 4 percent. Combining these figures, the total nominal growth comes to roughly 12 percent. This is also the kind of growth you can expect from equities.

To provide concrete evidence, Prashant Jain analyzed over 40 years of data, breaking down the SP BSE Sensex's Compound Annual Growth Rate (CAGR) into two periods:

1980-2000: 20.5% 2000-2024: 12.1%

Over the past four decades, the Indian economy has grown by 5.5-6.5 percent in real terms. However, since 2000, lower inflation has reduced nominal GDP growth, leading to lower returns from the SP BSE Sensex.

Prashant Jain projects that the Indian economy will slightly exceed 5-6 percent real growth. Even if this rate reaches around 7 percent with inflation expected to be 4-5 percent in the coming decade, he believes a realistic return from equities would be around 12 percent.

An In-Depth Look at GDP Deflator

To calculate these return expectations, Prashant Jain introduced the concept of the GDP deflator. This measure evaluates the impact of inflation on growth. Here’s what you need to know:

What is the GDP Deflator?

While Gross Domestic Product (GDP) measures the market value of all goods and services produced in an economy, the GDP price deflator tracks changes in prices of all these goods and services. It is a more comprehensive inflation measure than the Consumer Price Index (CPI). The CPI focuses on a fixed basket of goods, whereas the GDP deflator looks at overall economic activity from year to year.

Even if we assume 7 percent real growth and 4-5 percent inflation (CPI), the total nominal growth would still be around 12 percent.

Impact of Increased Investor Inflows

Should the increased inflows from Indian investors not lead to higher returns due to higher demand?

Prashant Jain argues that this overlooks the rise in stock supply. Many promoters are selling their holdings to capitalize on high valuations, thereby adding to the stock supply. This could offset the benefits of increased investor interest.

Conclusion

In conclusion, while the stock market can certainly offer attractive returns, setting realistic expectations is crucial for long-term success. A return of around 12 percent may be a more achievable target, given current economic conditions and market dynamics.

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