You can’t get away from volatility when you invest. Even if you hold a diversified basket of different stocks or bonds through a fund such as an index tracker, 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 returns ((i.e. Adjusted for inflation.)) seen from holding different UK assets over various time periods, going on historical data from Barclays:

Maximum and minimum real returns over different periods

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.

• Holding UK shares (equities) for one year, for example, has seen enormous variations in annual return – at the extremes as low as -60% over a year, to as high as near-100%.

• Hold shares for ten years, and the range of minimum and maximum annualized returns over that period is much tighter: From a worse case approaching -10% per year over ten years, to gains of more than 20% per year.

What volatility means for your investing

This graphic reveals some vital lessons for investors:

• Holding for longer allows good years to make up for bad years and vice versa, which averages out the returns.

• The smaller amount of dark blue to the left of the 0% line once you hold for longer than ten years shows it is fairly unusual for shares to deliver real negative annual returns over longer time periods. (Remember, these are the worse case runs over the past 100-odd years).

• Over one year, anything can happen!

• Volatility is the price you pay for potentially superior annual returns.

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, 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 have seen different returns over the past century. Investing in a global tracker is a good way to smooth your returns.

The bottom line is that if you pick a simple passive portfolio, save regularly, and rebalance 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.

Good reads from around the Web.

Simon Lambert at ThisIsMoney has done a deep dive on the recent household income and wealth figures from the ONS, and there’s something in there for everyone – from Jeremy Corbyn to Hyacinth Bucket.

For instance, your household needs to generate £84,747 of annual so-called original income ((Original income includes sources of earned income, such as wages, salaries and pensions, and unearned income, that is, income from investments.)) to be in the top-fifth in the UK.

Quite a figure, even in households with two earners, once you get away from London.

The median for the UK though is a less imposing £35,204. Perhaps that’s not a bad target for financial freedom? Remember it’ll need to go up at least with wage inflation.

Simon also reproduces an interesting graph showing what it takes to get into the top 1% in terms of total household wealth.

(The answer is a cool £2,872,600).

Again, median household wealth is a far more modest £225,100.

Pension wealth at 40% accounts for the largest proportion of the total. Property is second at just 35%. I presume this is due to the high net present value of all those final salary and public sector schemes out there among the oldies.

First among more equals

Simon notes that the ONS figures – when adjusted for benefits and taxes – suggest Britain is becoming less unequal in terms of income.

That’s true from what I’ve read elsewhere, but sadly it’s not due to a reversal in the income disparity as it’s popularly understood.

Average CEOs are still making far more than they should. And while the national living wage will help, I don’t think Britain’s lowest earners are making out like bandits.

No, it’s back to pensions again. The triple-lock for the state pension has transformed pensioners’ incomes in recent years.

It’s hard to begrudge pensioners escaping the poverty trap, but it’s worth remembering that they had at least a shot at owning their own homes and generating a nest egg over the past 40 years.

I wonder if even the most diligent of today’s youngest, poorest workers will get the same chances? If the robots don’t get them, then house prices will.

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Good reads from around the Web.

I bet you enjoyed stellar returns in 2016. Most well-diversified passive investors in the UK should have got into the 20% range.

Our own model portfolio flew up 25%!

It is easy to feel like you did really well last year, but a mistake to feel special. So put off the phone call to Foxtons and forget watching Billions or even Downton Abbey for lifestyle tips.

2016 was only a great year for most British investors because the crippled pound lifted our portfolios – both in terms of overseas holdings, and also by boosting our biggest multinationals.

And a currency shift is the most even-handed lift up (or slap down) that the market can give deliver. It’s largely blind to your talents, or otherwise, as an equity investor.

This chart of the FTSE 100 in pound, dollar, and euro terms is sobering:

Source: 3652 Days

You got much richer as a global investor based in Britain in 2016 because the UK got much poorer.

In the stocks

To do relatively badly in 2016 with equities you needed to be a stock picker, with all the wide dispersion of returns that entails.

Focusing on domestically orientated UK companies got full-time small cap investor Maynard Paton a bit over 7%, which is hardly a disaster. But a few wayward decisions saw John Rosier clock up minus 4%. Veteran investor and author John Lee [FT search result] did much better (and beat the UK index) with a roughly 18% showing from his UK companies, but even that hugely lagged a global tracker.

I’m not picking on these chaps to ridicule them, incidentally. As an active investor, I enjoy their writing and insights, and as best I can tell they’re all skilled investors.

I’m simply highlighting how easily (so-called) “dumb money” trounced the enthusiasts in 2016. ((I suppose it’s only fair to hint at my own returns, given all this finger pointing. I did better than those writers cited, but appreciably worse than a world index fund in sterling terms. And much of my gains were simply due to holding a decent slug of US stocks and other overseas assets.))

As an active investor you know you’re going to have bad years now and then. It’s the price of admission. Anyone who doesn’t is either a quant genius far above my pay grade (and theoretically prone to blowing up) or else they’re running a Ponzi scheme.

Besides, the majority of hedge funds delivered yet another lousy index-lagging year, too. Some of those guys are paid millions to deliver worse than nothing.

Pounded portfolios could recover

Returning to currency, one elephant in the room for active investors like myself, Paton, Rosier, and Lee is if and when the pound will reverse.

Normally long-term equity investors can choose to ignore currency fluctuations, for various reasons we’ll save for another time.

But the speed, scale, and political nature of the pound’s shock drop arguably means things are different today.

If the pound rallies hard, then UK stock picker’s portfolios pregnant with home bias should spectacularly outperform, all things being equal.

But all things are not equal, and for Brexit-phobes like me it’s a daily challenge not to try to see the UK markets through Marmite-coloured glasses.

As for the passive investors who hopefully make up the majority of our readers, I say enjoy those great returns.

Why not? The science tells us we feel losses twice as much as we enjoy gains – one reason so many people avoid investing in volatile shares in the first place. Perhaps taking a moment to appreciate the good times can help counteract that.

But remember the good times won’t last forever.

I’ve long been more optimistic about stock market returns than the gloomsters. But another crash someday is a nailed-on certainty, and the pound seems unlikely to fall so spectacularly again.

Remember, the long run real ((That is after-inflation.)) return from shares is about 4-6%, depending on who you read. When I hear even John Lee talking about a “steady, unspectacular year” which ended with a return three-times in excess of that, it does make me worry we might be getting complacent.

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