Learn About Investing
How much money am I going to make? It’s a reasonable question. Sadly, the answer may not be what you want to hear: don’t expect to get rich quick! On a brighter note, you can at least aim to get wealthier gradually.
If you want money fast, your options could include speculating or booking a trip to Las Vegas. In both cases, the risks involved are perilous and you can equally lose your shirt. Investing is different – seeking to manage risk in a more measured fashion.
OK, what’s the ballpark for investment returns?
Looking at what has happened in the past is a helpful way of putting investment returns into context, but there is no way of knowing what returns will look like in future.
Let’s first take a look at the average annualised returns for each of the three main asset classes – cash, bonds and shares – over different time periods in the UK.
Since the dawn of the 20th Century, investors have seen plenty of ups and downs and this long timeframe provides real perspective. Annualised returns over this period averaged out at 9.5% for shares, 5.4% for bonds and 4.9% for cash.
However, this nominal figure gets smaller once inflation is taken into account. The resulting real figures leave shares gaining 5.3%, bonds 1.4% and cash just 0.9% (annualised).
Asset class returns, 1900 – 2013
Source: Credit Suisse Global Investment Returns Yearbook 2014
Long-term averages, however, can be misleading. Stockmarket returns are extremely unpredictable. Returns for a particular type of asset are inconsistent from year to year and may vary a great deal over different periods of time.
If you open a regular savings account, it’s fairly easy to predict what will happen to your cash. If the account pays 2% over 1 year, you know your £100 will turn into £102. However, it makes sense to take account of inflation, which nibbles away at the purchasing power of your cash.
Bonds and shares, however, can swing about in price. This means that the experience of individual investors varies. Investment returns depend on when you buy and when you sell. Shares can be particularly volatile. Sure, average annualised growth over the long term may be 9.5% (without accounting for inflation), but then there have also been years when they lost a third of their value or risen by as much.
So, unlike cash savings, you don’t know what your returns will be in advance. The upside is that stockmarket investments have tended to be more lucrative than cash savings over the long term.
Different decades, different results
If you just looked at the period from 1980 to 2000, shares generated a startling 13% real annualised growth, compared with 7% for bonds and a relatively measly 1.75% for cash.
The decade after that looks very different though. The dotcom bubble burst and a global financial crisis meant shares had a rough ride. If you had invested in this asset class at the start of the decade you’d have been lucky to beat inflation by the end of it. Bonds did best, making 2% annually above the rate of inflation.
The spread in annualised performance between asset types is 1.75% to 13% in the first period (1980-2000), but just zero to 2% in the second (2001-2010). Plus, there is absolutely no reason to suppose that future returns will be similar to what’s happened in the past. Just because shares performed better than bonds on average over the course of a century, doesn’t mean they will do so during the period you are invested.
Figure returns for yourself
Of course, average figures won’t necessarily reflect your individual investment experience, or even anywhere near it.
Performance of individual investments deviate widely from the average for better or worse – as can the costs associated with owning them. You could buy a house that gains value while average prices drop or vice versa. Shares in a particular company may perform better or worse than the market average.
That said, the more you pay for an asset relative to its true worth, the less likely you are to do well out of it when time comes to sell. In other words, the price you pay for an investment is critical.
What does this all add up to?
Over the short term, stockmarket investments can be volatile, for better or worse. But volatility dampens down over time – which suggests investing works best if it’s done for at least five years and, ideally, ten or more.
Estimates provided by pension funds give an insight into the size of investment returns one might reasonably expect over the long term. The UK’s financial watchdog, the FCA, requires that they generate three projections showing what size of pension their clients might expect in future.
One represents a relatively pessimistic assumption about future annualised growth. The other end of the spectrum is optimistic and then there’s a forecast in the middle. Currently these are:
While these figures do take account of fees, they don’t factor in inflation, which is assumed will likely range between 0.5% (low estimate) and 4.5% (high estimate) with a 2.5% mid-point estimate. Inflation is subtracted from the nominal estimates above to calculate real growth.
At first glance, the resulting percentages may seem disappointingly small. The good news is that over the long term they are still enough to make a big difference to the size of your savings due to the effects of compounding.
To come back to the start: unless you want to take on huge risks, don’t expect to get rich quick. However, building wealth gradually is a realistic goal.
Stocks away! Shares outdo savings, bonds and gilts to earn investors the most over one, 10, 20 and 50 years
Highlights of Barclays Equity Gilt Study.
This Is Money
Table of historical asset class returns.
Handy data and graphs on historical asset class returns in the UK.
Table showing expected returns from a 60/40 equity bond US portfolio.