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What caught my eye this week.

Things are looking up for investors. Not because the markets have got off to a strong start in 2023 – the gains logged so far could reverse in a day – but because the pain of 2022 has set the stage for higher future returns.

This is often overlooked during a bear market, probably because those paying the most attention have already invested a decent sum of money. It hurts to see it hammered.

In contrast, those 20- and even 30-somethings who most benefit from the falls have often yet to realize they need to invest for the future. And they aren’t paying attention!

Or, if they are putting money into a workplace pension or similar, for many the sums at stake won’t seem life-altering or worth the headspace.

But those of us who understand compound interest know better.

Let’s say a 30-year old has amassed £50,000 in global equity tracker funds across their tax-efficient pensions and ISAs.

Assuming the future looks like the past in terms of returns, say 8% annualized, their pot might compound to around half a million pounds after 30 years – with no further contributions.

Perhaps if you told them that their future self had a future half a million quid on the line, gyrating with the markets whims during 2022, they’d have been more interested?

Probably best you didn’t.

I get knocked down, but I get up again

Back to 2022, and recall that those who can save meaningful money typically do so throughout their lives.

Let’s assume for the sake of simplicity that our young-ish saver adds another £5,000 every year to their initial £50,000 pot from age 30.

At the same rate of return, adding £5,000 a year, they should end up a millionaire by 60.

(Yes, a million will be worth a lot less in 2052, due to inflation. Trust me you’d still rather have it.)

In this case they’d already saved £50,000 by age 30. But over the next 30 years they’ll save and invest another £150,000 in our simplified illustration.1 Most of their earnings and savings are ahead of them.

For anyone in this position, market falls are good news. They lower the price of new purchases. Which in turn improves the odds of higher future returns.

Let’s assume the 30 years of £5,000-a-year saving came after a 20% bear market that took their initial pot down to £40,000 – but that future returns would afterwards be 1% higher. In this case they would end up around 14% better off than if the bear market had never happened.

Again, all very over-simplified. Some mathematically inclined readers are cross I’m using arithmetic returns and a compound interest calculator, others that I’m not belabouring sequence of returns risk, that I’m suggesting that a mere 20% correction would juice returns for three decades, or that I’ve talking about nominal rather than real returns.

Yes yes. This is a friendly illustration you can enjoy with a cup of coffee on a Saturday morning, not a dissertation. Besides, even if I wrote 5,000 words it wouldn’t change the point.

Which is that falling prices are good when you’re putting more new money to work – whether you’re buying a house, a hamburger, or another dollop of your fav index tracker.

Vanguard expected returns

So what kind of future returns can we expect from here?

Nobody knows in the short-term, but industrial-strength modelling can give credible ranges of probability over longer time frames.

Which is exactly what fund behemoth Vanguard has done for equities:

Graphic showing Equity market returns on a 10-year outlook

And also for bonds:

Sorry about all the small print clutter but it seemed best to include it – you know what giant corporations are like.

Remember too that these are expected returns, within ranges of probability. Note the outliers. Nothing is certain.

With all that said, these expected returns are much higher than what Vanguard was forecasting a year or two ago. Especially for fixed income.

Tubthumping

I doubt that after a terrible couple of years for bonds, the average investor would think that UK gilts are likely to deliver 4.3% a year over the next decade?

No, but as I wrote last November, bonds actually got more attractive – not less – thanks to the sell-off.

Again, these are all nominal returns. For sure if you believe inflation is going to stay above 10% for the next few years then you shouldn’t touch bonds with a barge pole.

However me and more importantly most economists think we’ll be back down around the Bank of England’s 2% target in a couple of years, if not before.

Enjoy that thought, the other links below – and the weekend!

p.s. Want more expected returns? GMO did a good job calling the 2021 exuberance. Here’s its new forecasts [PDF]. Note these are real returns this time.

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  1. In practice the amount they save would usually rise at least with inflation, and often far more with raises. []
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Image of a roaring wood fire

Today we’re kicking off our monthly interviews with Monevator readers who’ve achieved financial independence and/or early retirement (aka FIRE). In this debut episode, Mark Greene explains how a pretty conventional work-life and a lot of saving and investing unlocked an early and unusual retirement for himself and his wife. We hope it inspires you.

Also, I want to give a quick shout out to ESI Money, whose interviews with US millionaires inspired this series. Do check them out!

Okay, let’s get this show on the road – appropriately enough, as you’ll see…

A place by the FIRE

Hello Mark, thanks for sharing your life story with Monevator. To start with the basics, how old are you and yours?

I’m 51 and my wife is 57. We’ve been married for 28 years.

Do you have any dependents?

We never had children, and each have one surviving parent – mid-70s and mid-90s. Both are living independently at present and are not hugely reliant on us. Long may that last!

Whereabouts do you live and what’s it like there?

Since early 2020 we’ve been traveling. Most of the time we have been in our own motorhome. At present I am near the beach in the south of France, and it is very pleasant!

Did you have any second thoughts about FIRE – or traveling – given a global pandemic kicked off right at the same time?

If we had known the pandemic – and particularly the travel restrictions – were coming, it’s probable we would have delayed stopping work. That said, it suited both of us to have missed the ‘pivot the way you work’ that everyone else went through in the spring of 2020.

I’ve never had second thoughts about not working, but retiring early to travel was the main motivator for stopping work for my wife. She found the first few months under lockdown hard.

Now though, no regrets on either side!

When do you consider you achieved Financial Independence?

We retired in early 2020. I was 48 and my wife was 55. So I guess that was when we consider we reached financial independence. Whether our pot could have been considered ‘enough’ before there could be a point for discussion, but we worked to a particular date, rather than a particular amount – which we hope is more than enough.

My wife has done some very limited freelance work since, mainly to stimulate the brain than for the money.

I haven’t worked since. We have been filling our time with traveling, when allowed to do so through the pandemic.

Assets: only a little bit racy

What is your net worth?

We currently have about £1.1 million in investments, plus our house which is valued at about £600,000.

What are the assets that make up your net worth? Any mortgages or other debts?

In general terms, our main assets are:

  • One SIPP (invested in a range of stock and bond funds) £330,000
  • Three ISAs (invested in funds and many individual stocks) £635,000
  • Peer-to-peer lending (Funding Circle, Crowdstacker) £30,000
  • Property Investment Vehicle (Propertypartner) £55,000
  • Premium Bonds/cash £40,000
  • House £600,000
  • Total £1,690,000

One of us also has a small government pension due at 60. It’s worth a few thousand a year.

We have no mortgage or debts, other than current month credit card bills. These are paid off every month.

What was thinking behind the peer-to-peer investing?

Peer-to-peer was a way to diversify my asset allocation, chase a bit of a higher return, and to experiment with something new.

Tell me more…

Initially it was Funding Circle, which I was a big fan of until about three or four years ago. They diversified the loans automatically to spread risk, it was automated, and it provided good returns.

Funding Circle has switched off retail investors though, and now I’m just running down the balances as loans get repaid.

Crowdstacker was less liquid and very hard to diversify. A couple of loans defaulted and whilst supposedly asset-backed, the platform has had some real struggles realising value from the assets. Credit to Crowdstacker, I think they have managed it brilliantly, but I don’t expect to see much of those loans back.

My other loans with Crowdstacker have performed perfectly well though. I achieved rates of about 7% when the banks’ rates were under 1%.

Property Partner is another innovative finance platform. My investments are made into numerous companies that hold property and take capital gains and rental income, distributing dividends along the way. I really like the platform, and it affords me exposure to property (other than our former home) in a diversified way.

The property market has suffered through the pandemic. But again I’m very happy with how the management of the platform have handled it.

So much for digital property holdings – what about your main bricks-and-mortar residence?

Our former home is an Edwardian three-bed semi in a somewhat rural location in the Home Counties, near a commuter rail station. We own it and it is currently rented to a tenant while we travel.

Do you consider your home an asset, an investment, or something else?

While we are not living in it, we consider it an asset as the rent provides some of our income. Once we return to living in it, I would consider it part asset – as it has value – and part liability – because it costs money to live in.

Earning: doing it the traditional way

Tell us more about your old job…

I was in business consultancy and my wife was in training – of adults for professional exams.

Before this we both worked in local government jobs for a few years. That said, we had both done our last jobs for around 20 years when we retired.

…and your annual income?

Mine varied according to the success of my consultancy – I was self-employed – but probably averaged to about £60,000 of annual salary if it were a normal job. My wife was on a salary, which was about £80,000 at the end.

We have no formal income now. We live off our assets!

How did your career and salary progress over the years – and to what extent was pursuing financial independence (FI) part of your career plans?

We both switched careers and then progressed in earnings terms, though neither of our jobs had a traditional career ladder involving promotions and so on. For a few years my wife reduced her working hours slightly – and sacrificed salary – for a better work-life balance.

Other than seeking to maximise earnings in order to grow our assets, pursuing financial independence didn’t directly influence our plans.

Did you learn anything about building your career and growing income that you wished you’d known earlier?

We realised part way along the journey that it was better to work and earn less but stay sane, rather than go all out for a big income and suffer stress and other effects.

We delayed our FI date by a few years so that we could temper our workload – and spend a bit more on holidays – on the way.

Did you have any sources of income besides your main job?

No, we didn’t. We’ve had no significant sources of money other than our work – no side hustles and no inheritances.

Did pursuing FIRE get in the way of your career?

No, never. In fact the mental discipline required to plan for financial independence, and then execute on the plan every month, proved beneficial when applied to our professional careers too.

Saving: starting with an awesome budget

What is your annual spending? How has this changed over time?

Our baseline budget is just under £40,000. This goes up if we are on a major travel trip, but it’s all planned for in our mother-of-all-spreadsheets.

Do you stick to a budget or otherwise structure your spending?

Since we met 34 years ago, my wife has operated an awe-inspiring level of structure in our spending, so we have always budgeted and have always stuck to it. We allocate so much a month to various buckets of spending – food, drink, going out, bills, and so on – which smooth out big bills over the years and has allowed us to ensure we don’t spend on things we don’t really need, whilst still enjoying life.

What percentage of your gross income did you save over the years?

I have to say, I don’t know. It was lower when we started out as we earnt less and had a mortgage, but we never recorded what it was.

This was way before the days of the FIRE movement and an understanding of such numbers. We just saved as much as possible after we had funded the basic budget mentioned earlier. This meant any bonus, pay rise or a bumper year for my consultancy went into the FI pot – not on vanity purchases.

What’s the secret to saving more money?

My first ever financial advisor told us to find a level of life we were comfortable at, and then stick to that budget even if we earnt more, and to save the rest. That was arguably the best advice I have ever been given. In life and business we strove to spend less than we earned and to use the rest to grow an asset base.

I have also tracked our net worth for well over 20 years. Seeing it gradually increase as we paid down the mortgage and grew our investments was a good motivator to keep going.

Do you have any hints about spending less?

The game changed for us when we decoupled from the materialistic societal norms we are all surrounded by. The less we watched TV, read weekend newspapers or monthly magazines, the less we were exposed to ads telling us we would be happier if we only spent on X, Y, or Z.

Whilst all our peers were buying bigger houses, more cars or funding expensive hobbies, we were focusing on what we valued, which didn’t cost money – time together, simple hobbies, and so on.

Oh, and don’t have kids! That turned out to be a significant factor in our story.

Do you have any passions, hobbies, or vices that eat up your income?

Illustrative image of a motorhome: Retiring early to travel was a big motivation for this couple.
Retiring early to travel in a motorhome like this was a big motivation.

Our one guilty pleasure has been travel, which we have spent a lot on over the years. That said, we tend to travel cheaply – not backpacking, but definitely not five-star hotels and big meals out – so we can have a lot of experiences for what we spend.

We have banked some unbelievable memories from that spending.

Investing: starting outside a pension for early access later

What kind of investor are you?

My financial education started with the original Motley Fool in the mid-1990s, and then was influenced by Warren Buffet. So I have been primarily a buy-and-hold investor.

I started with managed funds, then moved into trackers as they became available and online trading became a thing.

For many years I did choose my own stocks. I’d buy in chunks of about £2,000 and try to build a diverse portfolio – although all were in the UK. Some were stars, and many were dogs…

Over the last ten years, as I learnt more and as the products developed, I have sought to consolidate into passive tracker funds. I’m a big fan now of Vanguard’s LifeStrategy funds.

What was your best investment?

In terms of headline percentage return from specific buys, Games Workshop, Novo Nordisk, and Unite Group have been big winners. But the actual return has hardly been life-changing.

Arguably my best investment decision was made firstly at 22 when I decided not to have a pension and invest in funds instead – so that I could access it early – and then a few years later deciding to manage it myself rather than through an adviser. That has made a huge difference in terms of that compounded percentage return over two decades of investing.

Can you tell us more about that decision not to invest in a pension?

When my decision not to have a pension was made in the mid-90s, SIPPs were never raised – even though they existed – and I’m not sure I knew enough to manage it all then. They were also not accessible at 55 at that time. And I knew I wanted the option to retire early, because of the age difference with my wife.

Once I had embarked on the ISA path, I just stuck with it for me – even when we were putting a lot into my wife’s SIPP.

Did you make any big mistakes on your investing journey?

If I had my time again, I would buy tracker funds from the off, not individual stocks. It was interesting to do, and made it partly a hobby. But for every tenfold grower like Games Workshop, there’s a total wipeout like Carillion or Laura Ashley.

As I mentioned earlier I also made some peer-to-peer loans that were in theory asset-backed, but were not immune to alleged illegal practice by company directors. I’ve mentally written off the loan, but court proceedings are continuing.

That bit where they say “you may not get your capital back” is there for a reason!

What has been your overall return?

My best guess would be an annual return of 4%, though I think it is probably a bit more. This includes keeping a reasonable amount in cash – over 20% of the portfolio – when interest rates were almost negligible, because we were approaching retirement. We wanted the security of knowing we were safe from sequence-of-returns risk in the first few years. It was also kind of handy when Covid broke the month we retired and the markets dropped 20%!

Listening to my own answer it strikes me that 4% doesn’t sound too great… But I have another rough calculation that suggests we more than doubled what we put in, partly through pension tax relief but mostly through compounding, because we’ve been doing this for over 20 years.

How much did you fill of your ISA and pension allowances?

Until we retired we filled our ISA contributions every year for most of the years. That – and compounding – is how we have amassed over £600,000 in ISAs.

I don’t have a pension at all so I never benefited from pension allowances. My wife has a SIPP. In the last few years of her working we maximized the contributions (including backdating) using cash we had accumulated.

That immediate uplift as a higher-rate tax payer is the best return we have ever had!

To what extent did tax incentives and shelters influence your strategy?

The tax rebate on the SIPP definitely influenced our decision to pour money in there in the last few years of working. Although the SIPP is just a wrapper, and the money would have been invested in the same thing in an ISA or in the pension.

How often do you check or tweak your portfolio or other investments?

Overall, I do a full evaluation every month, and have done for 30 years. This enables me to report our position to my wife, and to ensure I have an eye on the performance of individual investments.

In addition, I have a reasonable amount of our portfolio that I use to day trade on the ups and downs of the FTSE 100. This is my non-passive guilty secret!

Because of this part of the strategy, I am prone to checking the FTSE more than once a day. But I only ever do this around what we are already doing for the day.

Sometimes we will be off-grid and I don’t check for a week or more.

Wealth management: making it last

We know how you made your money, but what about keeping it?

The meeting of the two systems used by my wife and I enabled us to keep it.

My long-term spreadsheet and the plan to grow from nothing to our nominal £1 million retirement pot, coupled with her monthly budget and accessing only money available for planned spending meant we overcame the temptation to splurge or to fritter it away.

I was passionate about becoming financially independent and retiring early. That drove our behaviour every month, every week, and every day.

Which is more important, saving or investing?

Well, that depends what you mean by both terms. I see saving as money in the bank, investing as more risky options like funds or stocks. Saving is the essential first discipline, but bank interest rates will not grow enough to retire early. You need to take more risk and therefore invest.

When did you think you’d achieve financial freedom – and was it a goal with a timeline?

I thought it would be in my 50s. But then as the plan developed it became clear that with a fair wind it would be possible before that. The main driver was my wife’s age (she’s older), but I am proud to have got there in my 40s.

For the last ten years or so – once it was a clear goal with a very clear timeline – I told a LOT of people about. We really committed ourselves to it.

Did anything unexpected get in your way?

I’ve invested through three big recessions and crashes, though arguably that was expected – if unwanted – over a 25-year period.

Our life wasn’t without challenges, but from an investing sense nothing really got in the way.

Are you still growing your pot?

As we don’t have kids, our spreadsheet allows us to de-accumulate. But that could stretch out over a 50-year time frame or longer, so I am currently trying to maintain the pot.

With our spending heavily front-loaded so that we can make the most of retiring early – and with the tough market conditions since 2020 – that hasn’t always been easy. But we’re not too far off plan!

Do you have any further financial goals?

Ensuring the pot lasts long enough to pay the funeral bills, and not a moment longer. Who knows how far in the future that will be, so in the meantime I seek to do as well as I can with the assets we have accumulated. The targets are in my spreadsheet!

What would you say to Monevator readers pursuing financial freedom?

I genuinely wish Monevator had existed when I was in my 20s. There is so much more information available now, and it is so much easier to do with online platforms. My investing journey started before the internet.

A danger is though that one can spend too much time reading and learning, and not getting started.

Compounding is our greatest friend so, however small, start straight away and keep learning. Read and absorb and improve your strategy as you go.

Learning: starting young, headed to 100

When did you first start thinking seriously about money and investing?

At 22, when I took my first job and had to decide whether to have the company pension or not.

Did any particular individuals inspire you to become financially free?

My father was terrible with money and I didn’t want to be like him. I wanted the security of knowing I need never work again and I could live. That has always been my driver – because life is too short to waste working, even if you enjoy it.

Can you recommend your favourite resources for anyone chasing the FIRE dream?

Genuinely, Monevator! I think it is excellent and strikes exactly the right tone

If your only source of information – other than detailed personal tax and pension advice – was Monevator, you’d probably do well.

I am also now a massive fan of the Vanguard Life Strategy funds – inexpensive, easy to manage, and they take away the risk of paralysis by analysis. Rather than wasting hours optimizing the perfect asset allocation, trust Vanguard and spend the time earning more, learning more, or just enjoying your family.

Based on my own experience, I would work with a quality business or life coach to understand and plan what you really want from life and how you want to make it happen. The clarity that coaching gave me, on many occasions, changed my life.

What is your attitude towards charity and inheritance?

Being charitable is not just financial. I am intensely aware of our good fortune, and we have a budget (of course!) to make donations that help others.

We also now have the luxury of giving our time – either to support people we know, or to help organisations that have a broader impact. My life plan includes some form of major charitable service after we’ve finished traveling too.

Like everyone should we have also written our wills and they provide for charitable donations and inheritances for people we know who would benefit. We don’t have kids, so I guess we have less societal conditioning about who we leave our wealth to.

What will your finances ideally look like towards the end of your life?

Our plan allows for the money to last past our 100th birthdays. But the one thing I know for sure is that life never perfectly follows your plan.

We intend to enjoy the next 20 or 30 years as much as possible, and then anticipate a slowdown, but with enough funds to still enjoy life. If we go early and our beneficiaries gain, then so be it.

My dislike of the fees charged within the financial sector means we will probably avoid any managed products like annuities – but never say never. I enjoy learning about money and managing our finances, and I hope I have the acuity to do so for a very long time.

I guess the dream remains to have a wonderful life (which we do) without diminishing the pot.

So there you have it readers! FI by 50 and retiring early to travel and enjoy life on the road with his wife while they’re both young enough to make the best of it. Questions and reflections – on the concept of these FIRE-side interviews generally or on Mark’s journey specifically – are welcome below. But please do remember Mark is not a hardened Internet warrior like me and he is just sharing his story to inspire others, not to feed the trolls. Of course you can disagree constructively, but please keep that in mind. Thanks!

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Expected returns: Estimates for your investment planning

Expected returns are unpredictable. As symbolised by this picture of a pair of dice.

Understanding your future expected returns is an important part of your investment plan.

Your expected return is the average annual growth that you can reasonably hope your portfolio will deliver over time. It may be a real return of 4% per year, for example.

With a credible expected return figure you can work out whether you’re investing enough money to meet your goals – just by plugging your number into an investment calculator.

Give us a few minutes and we’ll show you how it’s done.

What are expected returns?

Expected returns are estimates of the future performance of individual investments – typically asset classes. Expected return figures are provided as average annual returns that you might see over a particular timeframe. Say the next five or ten years. 

The figures are usually based on historical data, but modified by current valuation metrics.

The Gordon Equation is the best known expected returns formula. 

Because future returns are highly uncertain, some sources offer a range of expected returns or probabilities. This emphasises the impossibility of precise predictions. 

Think of expected returns as a bit like a long-range weather forecast. You’ll get some guidance on conditions coming down the line. But expected returns can’t tell you when exactly it will rain. 

Even so, expected returns are a useful stand-in for the ‘rate of return’ required by investment calculators and retirement calculators.

For instance:

A retirement calculator picture shows you where to put your expected returns figure.

You’d put your portfolio expected return number in your calculator’s ‘rate of return’ slot.

By collating estimates for individual asset classes, we can calculate a portfolio’s expected return. See the table below.  

Moreover, because expected return calculations are informed by current market valuations, they may be a better guide to the next decade than historical data based solely on past conditions.

Expected returns: ten-year predictions

Asset class / Source Vanguard (30/9/22)  Research Affiliates (31/12/22) BlackRock (30/9/22) Monevator (21/1/23) Median (21/1/23)
Global equities 7.1 8.7 9 7 7.9
UK equities 5.6 11.4 8.2 8.4 8.3
Emerging markets 8.2 13 10.1 8.8 9.4
Global REITs 10 3 7.6 7.6
UK gov bonds 4.3 3.7 4 3.4 3.9
Global bonds (£ hedged) 4 4
Global aggregate bonds (£ hedged) 4.8 3.6 4.4 4.4
Inflation-linked bonds 7.5 3.5 5.5
Inflation 5.5 3.5 4.5

Source: As indicated by column titles, compiled by Monevator.

The table shows the ten-year expected returns1 for key asset classes, expressed as nominal average annual returns in GBP. 

We have sourced them from a variety of experts.

Monevator’s expected return on equities (including REITs) are calculated using the Gordon Equation.2

The expected return on UK government bonds is simply the prevailing yield-to-maturity of the ten-year gilt. 

For average inflation we used the ten-year UK instantaneous implied inflation forward curve (gilts) chart from the Bank of England

Make sure you subtract your inflation estimate from nominal figures. This gives you a real return figure to deploy.3

Their mileage may vary

As you can see from our table, opinions vary on the expected rate of return.

Methodology, inflation assumptions, and timing all make a difference.

Since our last update, Vanguard and BlackRock have both significantly increased their expected return forecasts. A market fall, ironically, leads to higher expected returns, because earnings and dividend yields improve. You’re paying less for future cashflows.  

Incidentally, Research Affiliates and BlackRock provide expected return rates for more sub-asset classes if those above don’t cover your needs. BlackRock’s tool even offers 30-year projections.

Of course, the longer your timeline, the bigger your pinch of salt.

Portfolio expected returns

Okay, so now what? 

Well, let’s use the asset class expected return figures above to calculate your portfolio’s expected return.

Your portfolio’s expected return is the weighted average of the expected return of each asset class you hold. 

The next table shows you how to calculate the expected return of a portfolio. Just substitute your own asset allocation for the example one below. 

Asset class  Allocation (%) Real expected return (%) Weighted expected return (%)
Global equities 60 3.45 0.6 x 3.45 = 2.07
UK equities 10 4.91 0.1 x 4.71 = 0.49
Emerging markets 10 5.28 0.1 x 5.28 = 0.528
UK gov bonds 20 -0.13 0.2 x -0.13 = -0.026
Portfolio expected return 3.06

Portfolio expected return = the sum of weighted expected returns. Giving us 3.06% in this example.

That’s pretty miserable. But it’s better than the 2.83% we were expecting only six months ago. 

(For this example I used Monevator’s nominal expected returns minus inflation to derive the real return.)

Feel free to use any set of figures from the first table. Or else mix-and-match expected returns for particular asset classes where you can find a source. Research Affiliates and BlackRock should cover most of your bases. 

The expected return of your bond fund is its yield-to-maturity (YTM). Look for it on the fund’s webpage.

Because most sources present nominal expected returns, remember to deduct your inflation estimate to get a real expected return. 

You should also subtract investment costs and taxes. Keep them low!

The expected return of a portfolio formula is therefore: 

  • The nominal expected return of each asset class – minus inflation, costs, and taxes  
  • % invested per asset class multiplied by real expected return rate
  • Add up all those numbers to determine your portfolio’s expected return

The resultant portfolio-level expected return figure can be popped into any investment calculator.

You’ll quickly see how long it’ll take to hit your goals for a given amount of cash invested.

How to use your expected return

Input your expected return calculation as your rate of growth when you plot your own scenarios

Drop the number into any good investment calculator or in the interest rate field of our compound interest calculator.

As we saw, the expected return rate we came up with in the portfolio above is pretty disappointing.

Historically we’d expect a 60/40 portfolio to deliver a 4% average rate of return.

But after a long bull market for equities and bonds – even given the recent declines – market pundits seem to feel there’s less juice left in the lemon. They’ve therefore curbed their expectations.

If you’re modelling an investing horizon of several decades, however, it’s legitimate to switch to longer-run historical returns

That’s because we can assume long-term averages are more likely to reassert themselves over 30 or 40 year stretches. 

The average annualised rate of return for global equities is around 5% since 1900. That’s a real return. Hence there’s no need to deduct inflation this time. 

UK equities weigh in around the same.

Meanwhile gilts have delivered a 1.8% real annualised return

Even though your returns will rarely be average year-to-year, it’s reasonable to expect (though there’s no guarantee) that your returns will average out over two or three decades. Because that’s what tends to happen over the long term.

Excessively great expectations

In contrast, planning on bagging a real equity return of 8% per year is living in LaLa-land.

Not because it’s impossible. Golden eras for asset class returns do happen. But you’ll need to be lucky to live through one of them if you’re to hit the historically high return numbers.

Nobody’s financial plan should be founded on luck. Luck tends to run out.

Opt for a conservative strategy instead. You’ll be better able to adapt if expectations fall short. And you can always ease off later if you’re way ahead. 

Remember your expected return number will be wrong to some degree, but it’s still better than reading tea leaves or believing all your dreams will come true. 

Don’t like what you see when you run your numbers? In that case your best options are to:

  • Save more
  • Save longer
  • Lower your financial independence target number

All are much preferable to wishing and hoping.

How accurate are expected returns?

Expected returns shouldn’t be relied upon as a guaranteed glimpse of the future, as if they were racing tips from a kindly time-traveller. 

Indeed the first time we posted about expected returns we collated the following forecasts:

Expected return predictions dating back to almost a decade ago.

These were long-range, real return estimates but the FCA one in particular was calibrated as a 10-15 year projection for UK investors. 

What happened? Well, the ten-year annualised real returns were actually:

  • Global equities: 7.8%4
  • UK government bonds: -2.6%5
  • A 60:40 portfolio returned 3.7% annualised

The expected return forecasts above now look amazingly prescient. They were previously far too pessimistic but the turbulence of 2022 has knocked both equities and bonds down a peg or three. 

Previously, 10-year actual returns were far ahead of the forecasts but one explanation is that our returns had been juiced by successive waves of quantitative easing from Central Banks. Perhaps, too, the retrenchment of globalisation is also a factor. 

Still, I wouldn’t expect even the greatest expert to be consistently on-target. Rather, it’s better to think of their expected returns as offering one plausible path through a multiverse of potential timelines.

Shock therapy

If you can stand it, go back to your investment calculator and dial in a more pessimistic scenario. Then plug in the lowest of all the respected expected return figures you can find.

Look at the pitiful outcome. Wonder if the decimal point got misplaced.

Scoring that nightmare onto your brain might stop you from anchoring on a shinier expected return.

Okay, that was horrible.

Now increase your expectations and peek at a rosier path for a quick morale boost. 

Feel better? More motivated? Great!

Now try to forget about the dream scenario, and simply invest for all your worth.

Take it steady,

The Accumulator

P.S. This is obvious to old hands, but new investors should note that expected returns do not hint at the fevered gyrations that can grip the markets at any time.

Sad to say, but your wealth won’t smoothly escalate by a pleasant 4% to 5% a year.

Rather, on any given day you have a 50-50 chance of tuning in to see a loss on the equity side of your portfolio.

Every year, there’s on average a 30% chance of a loss in the stock market for the year as a whole.

And on that happy note, I’ll bid you good fortune!

Note: this article has been updated. Some comments below might be past their Best Before dates. Check when they were published and scroll down for the latest input.

  1. Note that most corporates badge their expected returns calculations as ‘capital market assumptions.’ []
  2. Current dividend yield data comes from relevant Vanguard and iShares index trackers. We added on inflation to make our numbers a nominal return. This is purely for comparison purposes with other sources who use nominal returns. Inflation should be subtracted from all nominal expected returns so you’re working with a more realistic real return. []
  3. Real returns subtract inflation from your investment results. In other words, they’re a more accurate portrayal of your capital growth in relation to purchasing power than standard nominal returns. []
  4. Source: Vanguard FTSE All World ETF []
  5. Source: Vanguard UK Gilt ETF []
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Asset allocation quilt – the winners and losers of the last 10 years

After a bruising 2022, it’s time once again to take refuge under our asset allocation quilt. This colourful data duvet ranks the main asset classes (and sub-asset classes) by annual return over the last decade. The resulting patchwork of changing fortunes is a wonderfully intuitive way of illustrating how difficult it is to predict investing’s winners and losers in advance. 

The merest glance at the crazy clash of pixels reveals that any asset’s claim on the top spot is about as durable as the average K-pop star’s career.

But despite the explosion-in-a-Lego-factory vibe, the asset allocation quilt does have something to tell us about real diversification and its limits.

Let’s pull back the covers!

Asset allocation quilt 2022

Our updated asset allocation quilt is shown below.

The chart ranks the main equity, bond, and commodity sub-asset classes for each year from 2013 to 2022 from the perspective of a UK investor who puts Great British Pounds (GBP) to work:

The asset allocation quilt is a table that shows the annual returns of the main asset classes over the last 10 years.
  • We’ve sourced annual returns from publicly available ETFs that represent each sub-asset class.
  • The data is courtesy of justETF – an excellent ETF finder, screener, and portfolio building service.
  • Returns are nominal1. To obtain real returns, subtract 3.2% – the average UK inflation rate 2013-2022 – from the nominal figures quoted in this article.
  • Returns take into account the Ongoing Charge Figure (OCF), dividends or interest earned, and are reported in pounds.
  • Again, because readers are overlooking it – these are GBP returns. So if you’re a UK investor in the US, for instance, you did better than the S&P 500 index with your fund, because the pound weakened versus the dollar. (We’ve written more about such currency risk).

Changes from last year’s 2021 asset allocation quilt

We’ve added two bond sub-asset classes this year: 

  • Intermediate maturity US Treasuries
  • Long maturity UK gilts

It may seem odd to include more bond types after a disastrous year for debt. But I’d argue that a time of scorn is precisely when we need a deeper understanding of our antagonist. 

I’ve put US Treasuries in because they may offer superior diversification for UK investors in an era when the dollar is a safe-haven currency, and gilts are losing their lustre. (Political risk, anyone?)

That’s the theory, anyway.

The strategy depends on sterling dropping against the dollar whenever there’s a big dust-up on the global stage. Should that happen on cue, then a UK investor in US Treasuries can add currency gains on top of the government bond bounce we’d always hope for when equities wilt.

However – if the pound rose instead, then currency losses could undermine US Treasury returns at the very moment you want them to prop up your portfolio.

So holding un-hedged foreign bonds is not without risk. And indeed the unwelcome potential for an additional dollop of pain from such currency moves is precisely why traditionally we’ve always been advised to hold bonds in domestic or currency-hedged flavours.

What’s the evidence supporting US Treasuries?  

Intermediate US Treasuries have outperformed intermediate UK gilts from a UK investor’s perspective during nearly every equity market correction or bear going back to the dotcom bust – the one exception being the 2011 August downturn. 

However, Treasuries made a bad situation worse during the 1994, 1990, and 1987 market slumps. 

In the case of 1987’s Black Monday Crash, US Treasuries would have heaped a double-digit loss on top of the stock market pain.

In contrast gilts were a +18% oasis of calm that year. 

So switching to Treasuries is a gamble. A currency bet that paid off again in 2022 mind you, as sterling’s woes meant US Treasuries only lost -4.5%, versus intermediate gilts’ -24% swan dive. 

The longer-term situation isn’t so clear cut. US Treasuries beat gilts over the last ten years. But UK government bonds have outpaced US govies over different timeframes. 

Still, the notion that Treasuries could be a super-diversifier is intriguing. Hence we’re patching them onto the asset allocation quilt.

As we often say about such things, you could do, say, half-and-half – as opposed to going all-in on swapping your gilts for US Treasuries.

Stitch this 

Long-dated gilts also get an invite to the asset allocation block party because they offer something different.

Okay, so this year’s -40% loss is the kind of different you can live without, I hear you cry.

But let me explain.

The long duration characteristics of long-dated gilts make them extremely sensitive to changes in interest rates. 

That property can make long bonds the best diversifier in your portfolio during a recession, when equities and interest rates both go into retreat. 

But we saw the dark side of the bargain in 2022. Rapidly rising bond yields rendered long bonds radioactive and nobody wanted to touch them.

Ironically, current bond yields – which have come about precisely because of the 2022 slump in prices – have recharged the asset’s ability to deflect the next stock market implosion.

We’ll keep an eye on them in the quilt from here.

The final change we’ve made is to drop European equities to make room for these bonds. 

One more row of violent checks felt unpalettable, so they’re gone. Sorry. Not sorry. 

A chequered past 

It’s hard not to notice on eyeballing the quilt that broad commodities and gold were the only asset classes you should really have wanted under your Christmas tree in December 2021. 

For broad commodities, maintaining decent exposure is problematic, however.

A broad commodities fund uses futures contracts to track a diversified basket of raw materials – oil, livestock, cash crops, industrial metals, that sort of thing. 

And I’d bet hardly any passive investors held those commodity future funds last year, because as the quilt shows they inflicted hideous losses on investors from 2011 to 2020.

Notice how their orange blocks mostly prop up the bottom of the table – barring a brief Whac-A-Mole leap out of their hole in 2016. 

Most investors would have thrown in the quilt. I mean the towel!

However commodities did finally do their diehard fans proud in 2021 and 2022, with two big performances that almost make them look like worthwhile portfolio additions. 

Almost… but not quite. Their 10-year annualised return is still negative after inflation. 

2022’s commodities performance is akin to an expensive striker who’s essentially useless – but he came off the bench once, scored an absolute screamer, and won a famous victory. 

So you keep them on in the hope they’ll do it again. But mostly they just suck your soul. 

In investment terms, that translates as commodities delivering bond-like returns but with equity-style volatility over the long-term.

Or, to put it crudely: occasionally they’re brilliant but typically they’re terrible.

And the maths of that doesn’t compound into great returns over the long years.

Golden brown

Gold is potentially a more palatable alternative. Its position on the asset allocation checkerboard looks like the proverbial game of two halves. 

Gold is either vying for Champions League places, or flirting with relegation. 

Like its broad commodity cousin, then, gold is a diversification wild card. 

It exhibits near zero correlation with equities and bonds (i.e. anything could happen), it has poor long-term expected returns, but – as in the 1970s and in 2008 – in 2022 gold provided portfolio relief when other asset classes could not. 

Shady business 

Another bamboozler from the weird world of asset allocation is that inflation-linked bonds were a disaster just when you’d expect them to shine. 

Sadly, the inflation-linked bond funds that many people hold had quite high durations going into 2022. That left them vulnerable to interest rate rises. (We raised the alarm in 2016, but not loudly enough in hindsight.)

The pace of interest rate rises in 2022 hit these funds with capital losses that overwhelmed their inflation defences like a storm surge deluging a sea wall. 

So while investors should benefit from increased yields in the aftermath, the enduring lesson of 2022 is that protection is best sought via carefully-selected individual index-linked gilts, or short duration inflation-linked bonds.

Sadly, other useful inflation hedges are in short supply.

King of the swingers

Perhaps the swingiest asset on our disco dancefloor are the FTSE 250 equities. 

The UK’s mid cap stocks have been up and down like the Assyrian Empire as Eric Idle would say. 

A year of table-topping glory is invariably followed by 12-months of mediocre-to-dismal performance. 

What’s going on at the UK’s medium-sized firms? Does the workforce do one year on, one year off? 

My deeply boring rational brain is droning on about it [nerd voice]simply being an artefact of the timeframe and valuation multiples de-rating, actually…”

…whereas the superstitious, pattern-spotting side of my nature is already banking on 2023’s double-digit rebound. What could possibly go wrong?

Intriguingly, property is similarly whipsaw-y. 

It’d be interesting to see if a rebalancing bonus could be achieved by selling out of either asset after an exceptional year and buying in following a poor year. 

Passive investing luminary William Bernstein has previously advocated such a strategy with super-volatile gold mining stocks. 

But that’s enough naughty speculation for one year!

Full spectrum response

Take notice of how the multi-coloured mayhem settles into a more familiar array when viewed via the rightmost ten-year annualised returns.

  • Bonds, gold, and commodities are at the bottom of the heap, just as we’d expect.
  • Equities sit atop the ten-year column as prime slabs of capital really should.

But the divergent outcomes among the different equity sub-categories shows why we need all sorts of assets in our mix.

Long-term investing is a game of sliding blocks. The S&P 500 could easily trade places with the Emerging Markets or the FTSE 100 in the next decade.

Perhaps that’s why the asset class that makes the most sense is global equities. It hasn’t once reached No.1, but it’s still showing an amazing 10-year return. 

For sure, global trackers lag the US for now. But there have been many decades when the S&P 500 has been surpassed by the rest of the world. 

US equities just notched their lowest position yet on our ten-year asset allocation quilt, so perhaps they are finally coming off the boil. 

Still, the common thread here is expected asset class behaviour.

Over time equities of all stripes should do relatively well but we don’t know how the sub asset-classes will stack up. Meanwhile, the other asset classes are there to patch up the holes when bad years for equities leave our portfolios needing stitches.

Best to have a bit of (nearly) everything.

Maybe we should call such a portfolio an asset allocation pick-and-mix?

Take it steady,

The Accumulator

  1. That is to say they are not adjusted for inflation. []
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