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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 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 returns1 seen from holding different UK assets 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.

  • 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.

  1. i.e. Adjusted for inflation. []
{ 32 comments… add one }
  • 1 David @ MBA briefs March 5, 2010, 12:05 pm

    I agree with you 100%, ETF’s seem to give you the best of all worlds. I also like the graphic, great way to visually demonstrate risk vs. return. I was surprised to see that bonds could yield a negative return after 20 years.

    Have you ever looked at the Dow’s historical chart? It’s amazing how much it’s changed just in my lifetime. When I was born it was a little under 1,000, then by the time I was 5 it had dropped to as low as 577 but jumped back to 1,014 a little over a year later. The people who didn’t give up on equities in 1975 and invested in the market at it’s lowest point almost doubled there money in a year.

    Great article!

  • 2 The Investor March 5, 2010, 2:23 pm

    @David – Thanks for your thoughts. Yes, thanks to the bear market people currently have forgotten shares can go up as well as down Both the UK and US indices are up about 60% over the past 12 months since the bargain buying point in March. Friends who have kept trickling money into passive funds as advised over the past 3 years have done very well out of that bear market so far, although of course it could all plunge tomorrow, as ever.

    More cool data to come next week, so watch this space.

  • 3 Rob Bennett March 5, 2010, 6:08 pm

    you can’t get away from volatility when you invest.

    I disagree, Investor.

    I have a RobCast at my site entitled “Volatility is Optional.” It’s true that we cannot as individuals escape volatility. But as a society we certainly can.

    If you think about it for a few moments, you see that all overvaluation and undervaluation in stock prices is the product of emotion. If investors were not acting emotionally, stocks would always be priced properly (that is, the market really would be efficient). What if we encouraged all investors to invest rationally (that is, to take price into consideration when setting their allocations)? Both overvaluation and undervaluation would become logical impossibilities and stocks would always be priced at fair value.

    Fair value is the discounted value of the future income stream. The income stream increases by about 6.5 percent real per year because that is the average long-term return. So in a Rational Investing world, stock prices would go up by roughly 6.5 percent real each year like clockwork.

    Volatility Be Gone!


  • 4 UKValueInvestor March 6, 2010, 9:45 am

    Your graphic certainly does a good job of showing why it’s so important to know how long you’re going to be investing some money for. If it’s for next year’s holiday, stocks are probably a bad idea. It also ties in with the ‘glide path’ approach to asset allocation as you approach the withdrawal phase, which is another interesting topic in itself.

  • 5 GloballyMobile March 7, 2010, 8:52 pm

    For a very interesting analysis of volatility – and, just as important, correlation between asset classes, which is more subject to volatility than most people realise – see the Alliance Bernstein paper at http://tinyurl.com/ydctlh6
    I have no connection to Alliance Bernstein, but do think they are on to something.

  • 6 The Investor March 8, 2010, 2:34 pm

    Thanks everyone for your comments. @UKValueInvestor, one way to sidestep equity volatility is to concentrate on income. That way you don’t need to sell to withdraw. Pretty feasible in the UK with our big yields, though there will be ups and downs of course.

  • 7 The Investor March 8, 2010, 6:03 pm

    @Rob, I know where you’re coming from with these comments because we’ve discussed it a dozen times, but in real life it’s not that simple. Aggregate stock market returns over the long-term may be around 6.5% real, but in the short term anything can happen because future earnings of any particular company or even the market as a whole are not that predictable.

    As a result, the idea that volatility can be banished is dangerously wrong, in my view.

    I’ll do a whole post on this to explain my thinking in more detail, so let’s leave it there. (If you’d like to discuss further on your own blog, link here and I’ll trackback and contribute in the comments if I get a chance).

    Best regards.

  • 8 diy investor (uk) January 17, 2017, 12:33 pm

    For me, volatility from equities is possibly the most difficult aspect to come to terms with. I think that is why it is important to get the balance/mix of assets right and make sure it corresponds to your personality.

    The other important related aspect is reversion to mean and rebalancing between equities/bonds to smooth out the ups and downs. This is a feature of the Lifestrategy funds which I like so much.

  • 9 tom January 17, 2017, 1:49 pm

    Doesn’t Howard Marks suggest that volatility isn’t necessary to produce above average returns – if you buy assets cheaply?

    This probably veers down a wormhole of subjective definitions of volatility and risk and how to value assets…

  • 10 tom January 17, 2017, 1:51 pm

    p.s. Of course I accept and agree that volatility in the short-term is unavoidable.

  • 11 Gregory January 17, 2017, 2:09 pm

    If Your portfolio is well diversified (equities, bonds, commodities) volatility is Your friend in the long run.

  • 12 Gregory January 17, 2017, 2:18 pm
  • 13 nick January 17, 2017, 2:30 pm

    What if you’re pretty much at the beginning of your passive investment adventure? Everything seems stacked poorly. The fall of the pound has made globals very expensive and very vulnerable to currency movements, the FTSE is high due to the weak pound benefitting exporters, bonds are high. There doesn’t seem to be much good news if you’re just starting out – can you offer any advice?

  • 14 dave January 17, 2017, 6:01 pm

    Same situation as Nick what advice can you offer?

  • 15 Jaygti January 17, 2017, 8:07 pm

    I would say if your a purely passive investor, then just keep sticking your money in monthly and forget it. Just rebalance ever so often , to keep your allocations about right.
    A “proper” passive investor wouldn’t be trying to time the market.

  • 16 Robert January 17, 2017, 9:40 pm
  • 17 The Rhino January 18, 2017, 10:58 am

    @nick and dave – maybe one approach is to think back to the past and consider points in time where it was a bad time to invest. Inevitably these times were followed by a time when it was a good time to invest. The takeaway being that even if you start investing at a bad time, you will eventually be investing at a good time if you stick with it. Over a long enough time, as the OP chart demonstrates, you will prob. see the mean return you are after.

    TL/DR; just get on with it and stop worrying about when to get in..

  • 18 The Investor January 18, 2017, 11:11 am

    @nick @dave — Do you remember what the economic situation was in 1977, and how global markets were valued? What were the prospects then for share investors, I wonder? I’m not being facetious — the point is today’s levels will be irrelevant from the perspective of a young investor with many decades of investing ahead of them.

    You have a big advantage over the old if the market is overvalued, which is that you haven’t got much of your lifetime savings at risk yet! And if it turns out it wasn’t overvalued, you’ll be glad to have gotten started.

    As @jaygti says, from a passive perspective one should just get started with a sensible plan that’s appropriate to your circumstances, and then get on with life.

    All that said I agree the extreme political/currency risk makes things particularly strange for UK investors at the moment, and I hope to cover this in an article soon. But fact is most people will do better to never go down the worm hole, as Tom puts it, of all that! 🙂

    @tom — Yes, as you sort of allude, nearly everyone is not Howard Marks and will come a’cropper trying to buy cheap. (I’ve even read comments from him that he couldn’t build up the business he did starting today, because of the greater efficiencies in credit markets and so forth). Of course anyone is welcome to try — I do! — but for most a plan that accepts volatility and builds it in (such as drip feeding monthly into a basket of assets over 30 years and rebalancing annually) is going to work out much better.

  • 19 FIRE v London January 18, 2017, 1:02 pm

    Excellent graphic, TI. One of the best summaries of what we’re all doing, ever.

    But I chuckled at your “Our big yields [in the UK]”. If you think UK yields are high, try Australia! Market average yield is over 5.5% (iShares’ IOZ ETF: 5.88%).
    In all seriousness, don’t try Australia, no. More to the point, beware yield traps and falling/volatile currencies. S&P has significantly outperformed FTSE in any currency over most sensible timeframes, despite always having a lower yield.

  • 20 The Investor January 18, 2017, 1:12 pm

    @FvL — Cheers. Re: The big yields, that was a comment from 2010… 🙂

  • 21 SurreyBoy January 18, 2017, 6:47 pm

    Talking of yield – on the HL site the HSBC FTSE 100 index tracker class c is yielding 5.68%. Is that right?

    On volatility, like many on here my humble portfolio has ballooned in sterling terms recently but taken a beating this week (mix of UK and global equity funds) and the blinkin bonds have dipped too although not as much.

    Hands up – i get more cross by theses pretty modest falls than any “joy” when the values rise. Even though i know volatility is inevitable (and necessary), it still irritates me when i watch it go down. I cant help it, its just how i feel.

    Before anyone tells me to get out of the kitchen if i cant stand the heat, i can stand the heat – but i need to accept that even a few % points drop does actually wind me up.

    There – ive come out and said it – i fell much calmer now!!

  • 22 Tony Reid January 18, 2017, 9:00 pm

    @surreyBoy. How do you think it feels with 10 weeks to FIRE?

    Will someone eradicate this ‘earworm’ that keeps saying “sell up and go into cash’?

  • 23 TT January 18, 2017, 9:02 pm

    In these times of bond skepticism it would be nice to show and contrast against the portrayed bonds and equity volatility/performance how a 60/40 portfolio is less volatile and yet performs admirably.

  • 24 John B January 18, 2017, 9:26 pm

    Volatility is a problem if you are adding or removing large sums at any one time, say investing an inheritance or buying a house. If you are drip feeding into a scheme, and drawing down gradually, much of the problem goes away. The worst thing is to chase market trends or panic, as then you will be buying high, selling low.

    @nick @dave You won’t be getting great returns, but you might as well start. Look up Pound Cost Averaging, and keep the sums small, just beware of broker transaction fees.

  • 25 woody January 19, 2017, 2:01 am


    Having comprehensively read your site – and generally been persuaded by the merits of passive investing – I invested in the lifestrategy 100. It went up 4% in a couple of weeks, then I cashed out and invested it all in an emerging markets fund.

    It might seem insane, but hear me out.

    I’m 30 with a chunk of cash to start off my investing.

    I figure both the risk and expected return in the emerging markets over ~30 years is a fair bit higher than your standard mostly-developed-world global tracker, so I want to invest in those first.

    This is currently 100% of my portfolio. Gradually over the next few years, I hope to feed into lifestrategy as much as possible to build up the developed world exposure and counterbalance the insanely risky/hopefully very rewarding emerging market equities part of my portfolio.

    In 30 years, if I’ve been able to save as much as I hope, the EM part will be ~10% with the remaining 90% in a dev. world global tracker.

    Is my approach really so crazy?

  • 26 Rolf January 19, 2017, 8:25 am

    I have to say I find that one-year best-case return on cash interesting. What was the year that saw 40% (!) deflation? And what happened to the economy afterwards? Was it perchance Churchill’s disastrous return to the gold standard?

  • 27 The Rhino January 19, 2017, 11:45 am

    @woody – yes, thats insane. If you’re making spur of moment decisions radically changing asset allocations you are probably going to end up with poor long-term returns unless you happen to be in possession of that vital active-investing ingredient, ‘edge’. Otherwise, its a classic anti-strategy to under perform the market.

  • 28 SurreyBoy January 19, 2017, 12:59 pm

    @woody, i dont think i would say what you have done is insane, but is potentially unwise. If you have the temperament and personal circumstances such that you can leave the investment alone for 30 years, and will subsequently diversify, then things will probably be fine. The risk is that higher volatility EM tanks in the early days and you sell on a bad dip, or you need the cash and you sell on a bad dip etc.

    Having said that, the conventional approach is to start with a UK and global fund, and then diversify out to other areas. So i guess your approach of starting somewhere and then diversifying is sound, but personally i would not have started in something so potentially volatile. Then again, others will tell you that developed markets are too expensive right now etc etc, so i can see your logic. Were it me – a diversified basket would be preferable from the start, but that suits my attitude to risk – which is that i accept it because i have to but dont want more than necessary.

  • 29 John B January 19, 2017, 2:30 pm

    @woody, if you don’t need the money soon, investing in something as volatile as emerging markets is fine, for the reasons you state. But beware of grand gestures and fiddling. If you start celebrating your successes and bemoaning your failures, you will become a gambler, and transaction costs and bad timing as you chase trends are likely to hit you.

  • 30 Will S January 19, 2017, 6:23 pm

    @Woody Something to think about is that emerging markets may not beat developed… “Numbers from the World Bank’s International Finance Corporation , for instance, reveal that $ 100,000 invested in a broad, random selection of emerging market stocks in 1985 (the earliest date from which we have emerging market data) would have been worth $ 1.08 million by 2006. The same $ 100,000 invested in U.S. markets would have grown to more than $ 1.3 million.”

    @Nick @Dave I’m in the same position. Just starting out with shares across the globe at their peak. What to do? Wait and assume they will crash? However they may not. We don’t know what will happen. Best to start drip feeding each month and aim to invest for the long term. As my current new favourite saying goes “it’s not timing the market, its time in the market”.

  • 31 The Investor January 19, 2017, 8:56 pm

    @Woody — I follow your logic. But going “all in” is in my view not a helpful habit to pick up, whether your a passive or an active investor. That’s not to say it won’t work — I agree the valuations look favourable — but it could almost be more dangerous if it does because you’ll do it again, and eventually it won’t… 🙂

    I think a better habit if you want to fiddle and know better (I speak as a practitioner of the fiddling and thinking I know better school, so nothing personal) is the learn to tilt/overweight. So one might go say (off top of my head) 50% global / 50% emerging market, for example, rather than 0%/100%.

    When you’re starting out, the aim of the game is to stay in the game. You might not always be as into investing as you feel right now. Particularly not if EM halves and developed markets double.

    Not saying that will or won’t happen. I am talking about processes, not prognostications. 🙂

    Anyway, best of luck with your investing whatever you do. Glad you’re enjoying the site.

  • 32 JohnG January 19, 2017, 10:38 pm

    @woody I’d be inclined to unwise rather than crazy. You’re effectively betting on the assumption that emerging markets will outperform developed which I’m not sure there’s historic evidence to support or an overwhelming argument to support. Betting everything on a roulette wheel is a very risky strategy but it doesn’t follow that the average reward is higher because of this.

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