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Volatility, inflation, and asset class returns

You can’t get away from volatility when you invest. Even if you hold a diversified [1] basket of different stocks or bonds through a fund such as an index tracker [2], over shorter periods of time the annual returns from the different asset classes can really vary.

The following graphic shows the range of annual real returns1 [3] seen from holding different UK assets [4] over various time periods, going on historical data from Barclays:

Maximum and minimum real returns over different periods

Note how the variation in returns decreases the longer you hold.

Source: Barclays Equity Gilt Study 2016

As we move up from bottom to top, we’re looking at holding the asset for longer periods of time. The highest and lowest annualized returns over each time period are shown by the bars.

What volatility means for your investing

This graphic reveals some vital lessons for investors:

Also notice that because the average real annual returns from cash and bonds are low compared to shares, a period of high inflation can see them still post negative real returns even after 20 years.

‘Real’ annual returns take inflation into account. A real return of -1% over 20 years means that factoring in inflation [5], your investment lost 1% of its spending power per year over the two decades.

Over the past 116 years, UK shares have never posted negative real returns over periods longer than 23 years. Indeed, for holding periods for 20 years or more the minimum real returns from equities have been better than from lower volatility cash or bonds. This is why shares are the best asset class for long-term savings.

Remember too that we’re just looking at UK returns here. Different markets around the world [6] have seen different returns over the past century. Investing in a global tracker [7] is a good way to smooth your returns.

The bottom line is that if you pick a simple passive portfolio [8], save regularly [9], and rebalance [10] every now and then, such fluctuations become much less critical. The good and bad periods of returns for the different assets should be evened out.

  1. i.e. Adjusted for inflation. [ [13]]