Many investors have a misconception that their equity portfolios yield a solid 12% annually. However, certified financial planner Ritesh Sabharwal sheds light on a different reality when factoring in inflation and taxes.
In a recent post on LinkedIn, Sabharwal pointed out that the actual return on a 12% equity investment is closer to 6.7% when considering taxes. This crucial aspect is often overlooked by many investors.
Sabharwal emphasized the impact of inflation on long-term returns, highlighting the importance of using the real return formula to assess gains accurately. By applying the formula, a 12% equity return diminishes to 6.7% with a 5% inflation rate. After factoring in a 12.5% long-term capital gains tax, the final return stands at a mere 5.8%.
Regarding fixed-income options like savings accounts, fixed deposits, or debt funds, Sabharwal cautioned that investors may experience negative real returns post-inflation and post-tax, leading to a gradual erosion of their wealth over time.
Illustrating the gap between paper returns and actual wealth, Sabharwal exemplified a Rs 1 crore portfolio, where a 12% return on paper translates to only Rs 5.8 lakh after adjusting for inflation and tax implications.
Sabharwal stressed the importance of significant equity exposure for long-term wealth accumulation, advocating for a steady approach that focuses on real returns rather than headline numbers. He recommended a strategic allocation and a long-term perspective, suggesting the use of simple index funds for those new to the equity market as a starting point for wealth creation.