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The Actual Catalysts For Better Returns

  • Writer: Akshay Nayak
    Akshay Nayak
  • Jun 20
  • 5 min read

Maximising investment returns is a core objective for almost all investors. Taking incremental risk is usually perceived to be the best way to boost returns. This implies a positive and linear relationship between risk and return. But such an understanding of the relationship between risk and return is completely flawed. This is because if investing in riskier assets meant getting a higher return, there would essentially be no risk. Our investment process is a much bigger catalyst of better investment returns. A sound investment process has multiple elements. Each element contributes to better returns. But these elements are abstract. They are therefore hard to quantify.


The American investment firm Vanguard publishes an annual research study. It lists out the various elements of value added by a sound investment process. It also shows how much each element adds to long term returns. The latest such report came out in February 2025. The various elements of a a sound investment process and their impact on net long term returns (in terms of basis points) can be found in the graphic that follows.

These figures are based on data collected in America for American individuals. But the elements of value add are universally relevant. We must therefore understand how each of these elements makes a difference. And today I will be dissecting each of these elements to show how they add to long term returns.


Asset Allocation


Asset allocation forms the basis of any individual's portfolio. The report does not assign a specific number to the exact value added by optimal asset allocation decisions. This is because each individual's temperament, risk profile and financial goals would differ. So the amount of value added by optimal asset allocation decisions would be subjective. It has therefore been assigned a value greater than zero.


This does not change the fact that sticking to a simple asset allocation strategy enables individuals to block out unnecessary noise. This allows them to focus on achieving results that make a tangible difference to their financial well being. In fact, even the most basic asset allocation strategy of 60% equity and 40% debt can drive returns that are better, sustainable and satisfactory. Asset allocation is therefore a clear catalyst of better returns. Hence individuals must ensure that they focus on asset allocation when designing portfolios.


Simple, Low Cost Products


Choosing simple, low cost products (usually index funds and ETFs) to execute asset allocation strategies can boost portfolio return for clients. The latest Vanguard report pegs the value added by the use of low cost products at 30 basis points or 0.3%. These incremental returns arise because the lesser we pay in costs, the more we keep for ourselves. Keeping costs low becomes even more crucial in low return environments. This is because when low returns are combined with high investment costs, investors would be left with next to no returns from their portfolios. The variety of choice among low cost investment products makes cost effective implementation that much easier. More insights on the subject can be found in my earlier article Defensive Investing Decoded - III : Constructing Defensive Portfolios


Regular Rebalancing


Letting a portfolio drift without rebalancing it may lead to equities being over weighted in the portfolio. This may boost portfolio returns. But it also leaves us vulnerable to steep corrections and market crashes. In fact a 60-40 stock-bond portfolio that is not rebalanced has been shown to carry a degree of volatility that is comparable to an 80-20 stock-bond portfolio. This is laid out in the graphic that follows.

It is important to remember that returns can only be evaluated in hindsight. A client’s investment experience would come before they enjoy their returns. So creating portfolios that ensure a comfortable investment experience is of vital importance. Regular rebalancing reduces portfolio risk. This smoothens the investment experience thereby improving it. Effective portfolio rebalancing has been shown to add 12 basis points or 0.12% to long term returns. Hence it is an important element of the value add that investors can leverage.


Tax Alpha


The latest edition of the Vanguard report shows that optimising the tax mix of assets in a portfolio can add upto 60 basis points or 0.6% to long term returns. This is because taxes are an obvious drag on portfolio returns. So optimising tax costs in a portfolio allows investors to enjoy more of the returns they earn. This represents a concept in finance known as asset location or tax alpha.


In America, there is the concept of taxable and tax advantaged investment accounts. So tax alpha is achieved by coming up with an appropriate division of investment assets between both kinds of accounts. Such a concept does not currently exist in India. So tax alpha would have to be generated at the product level. This can be achieved through tax efficient product choices (i.e. investing in products such as PPF, NPS, ELSS, mutual funds and so on). Having one component of the portfolio in such products would help optimise tax costs.


Withdrawal Strategies Post Retirement


Deciding the quantum and source of annual portfolio withdrawals post retirement is a crucial aspect of post retirement financial planning. As per the latest edition of the report, this adds upto 120 basis points or 1.2% to long term returns. Effective portfolio withdrawals require choosing an optimal portfolio withdrawal strategy. The strategy chosen would depend on the available retirement corpus and the specific needs of each individual. More on the subjects of portfolio withdrawals and withdrawal strategies can be found in my earlier articles Retirement Investing - II : Managing Withdrawals Post Retirement and The Why And How Of Portfolio Construction In Retirement.


Focusing On Total Returns


Some individuals may have the option of living off the income from their portfolios (dividends from stocks, interest from bonds and rent from real estate). But this may not work in a low return, high inflation environment. The real value of cashflows from portfolios are likely to be significantly reduced. The Vanguard report therefore recommends a shift to a total return approach. It focuses both on capital appreciation and portfolio income. The exact value add from such a shift for each individual cannot be reliably measured. This is because each individual's spending patterns and overall portfolio composition would differ. Therefore the exact amount of value added in terms of incremental portfolio return would be subjective.


Nonetheless the shift to a total return approach would expose individuals to lesser risk from their portfolios. It would also enhance tax efficiency and reduce longevity risk. Therefore, individuals must consider making the shift to a total return based strategy if it serves their best interests.


Behavioural Discipline


This is the one element that makes a bigger difference to long term returns than any other. Investing is significantly influenced by human emotions. Therefore individuals must maintain a long term perspective and disciplined approach towards their financial planning endeavours. The latest edition of the report pegs the value added by disciplined investment behaviour at 200 basis points or 2% in terms of incremental long term portfolio returns.


Investors must therefore learn to use emotions to their advantage. There may be times where they feel tempted to abandon their financial plans. This usually happens because the right outcomes may not yet have been achieved. They must then remind themselves of the benefits of not acting under the influence of their emotions. This would help them remain calm and overcome their tendencies to do the wrong things at the wrong time. And this would ultimately help drive the right outcomes for them.


Final Takeaways


There is currently no equivalent of the Vanguard research report available for the Indian context. So it is not possible to quantify how much value each of these elements would add to investors in India. But the reasons why each of these elements add value to portfolios remain largely similar in India. So Indian investors would also benefit from incorporating these elements into their portfolios and financial plans. This would help each investor drive the best possible outcomes for themselves.





 
 
 

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MUHAMMAD KAMAAR SITE MAKER.4US
20. Juni
Mit 5 von 5 Sternen bewertet.

Yea that's right 👍


Highly recommended, you know?

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Disclaimer : The information given in all articles on my blog Finance Made Fun For Everyone is meant for educational purposes only. None of the information given in any of these articles must be construed as investment advice. Readers are advised to act on information they find in this blog at their own discretion after adequate due diligence. 

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