Experts have warned us to prepare for low returns from investing for years now.
Count me as skeptical about the value of such predictions.
You may recall in 2012 the UK regulator dropping a bomb on pension forecasts [1].
The FSA1 [2] told financial providers to project low returns into the future, compared to the higher gains enjoyed in the past.
But as I opined [3] at the time:
… here we have the regulator rolling up to the scene of the crime not long after the worst decade for equities relative to bonds (the worst two decades, even) to warn us – wait for it – to temper our expectations.
As far as useful advice goes, this is a bit like Eva Braun showing up in London in the middle of the Blitz to warn Churchill that her boyfriend seems a bit obsessed with guns.
The Investor, Monevator, November 2012
I suggested returns would likely be healthy going forward. Happily, that optimistic view has been borne out so far.
- Government bonds have done very well since November 2012.
- Global equities have returned more than 130% for British investors.
- We have seen relatively low returns from UK shares since 2012, but I don’t believe the FCA foresaw Brexit. Besides, the FTSE All-Share still gave you 70%, with dividends, since November 2012. Hardly a disaster.
To be fair, regulators must err on the side of caution. It’s their role. If you go to a job interview at a regulator, you should get extra marks if you sniff suspiciously over the biscuits.
Nobody should want a regulator to be mad for it.
Low returns for Generation Z
However when academics like the number-crunchers behind the Credit Suisse Global Investment Yearbook warn us to prepare for low returns in the future, you have pay some attention.
The respected trio of Dimson, Staunton, and Marsh are not a 1960s folk outfit who sang about sandals, but rather three London-based academics. And they dropped their prophecy of doom in the latest edition of their Yearbook.
The threesome point out that expected real returns (that is, returns after adjusting for inflation) from safe government bonds are very low these days. Negative, even. Not very enticing.
They then provide evidence that low real yields have previously correlated to lower returns from other asset classes, too.
Finally, they reveal the horror-graph below.
Warning! If you’re under-35 and you’ve just started investing, make sure you’re sitting down.
[4]Source: Credit Suisse Equity Yearbook 2021 [5]
Previous generations – led by those blessed Boomers, naturally – have enjoyed many bountiful decades as investors.
Crashes have come and gone. But global equities have still delivered on average 5% or more in real terms on an annualized basis.
Bonds also did great, particularly recently. Notable given their lower risks.
However if you were born after Nirvana’s Curt Cobain shuffled off this mortal coil then you’re twice cursed.
Dimson, Staunton, and Marsh have run the numbers. They think Generation Z – those born in the mid-1990s or later – can reasonably expect to earn 3% in real terms from equities.
That is far less than the 5% or more we’ve seen previously. And it’s worse than it possibly appears at first glance.
- For example, save £10,000 a year and achieve a 5% annualised real return and you’d have nearly £700,000 in today’s money after 30 years.
- But at 3%, you’d be left with slightly less than £500,000.
Over many years, that extra 2% adds up to a whole lot more.
As for bonds, Dimson, Staunton, and Marsh expect negative real returns.
I think private investors might as well hold at least some of their bond allocation in cash nowadays, as we’ve said before [6]. You’ll still get a negative real return, with today’s interest and inflation rates. But your cash will have zero volatility and downside, and it can be reinvested later in better times.
Note: this isn’t something to decide on a whim! Government bonds can provide proven diversification benefits [7] versus equities in times of stress. You won’t get that from cash.
Remember you don’t have to (and probably shouldn’t) go all in/out. You could do say half your fixed income allocation in bonds, and half in cash.
What are you going to do about low returns?
Unlike in 2012, I’m not quite so ready to push back against this gloomy forecast.
For one thing, these guys are renowned academics – as opposed to a regulator with an interest in scaring us into being more financially prudent.
More importantly, we all know that risk-free government bond yields are indeed still incredibly low. Negative, in some cases, in real terms.
Clearly we must expect low returns from an asset class that’s nailed-on to give us worse than nothing, after inflation. (If we see deflation, government bonds will do better. But trust me, you don’t want to root for deflation.)
All other asset classes key off the yields available on (presumed) risk-free government bonds – especially the yield on US Treasuries.
As I’ve explained [8] previously, this includes the returns you can expect from equities. So dumping your bonds and expecting a bumper harvest from shares is – at the least – naive.
If the academics are right (I’m not convinced returns are predictable, but they have more letters after their names than me) then what can you do?
Well, what you can’t do is change when you were born. You have to play the hand you’re given.
Focus on what you can control if you want to deploy countermeasures:
Check your investing costs
If real returns from equities are only going to be 3%, then the difference between using index funds that charge 0.4% and funds that charge 0.1% is 10% of your total expected real return. You can’t afford to waste money like a Boomer, so switch to the cheapest funds [9]. Same goes for brokers [10].
Save more
Can you trim more savings [11] from your lifestyle run-rate? Can you put more money into your pension to earn an additional employer match and a tax relief bump? Saving more is the surest driver of a better final result.
Invest for longer
A close second is allowing your money to compound for longer. Compound interest [12] takes time. More time compounding means more years to save, too. Finally, the later you leave it to start drawing [13] on your pot, the fewer years your portfolio will need to sustain you. Just don’t wait forever!
Lower your expectations
If you lower your expected returns and you don’t want to save more or retire later, you might make do with less. The Retirement Living Standards [14] initiative tries to project how much income you’ll need to retire to a given level of comfort. Could you handle ‘moderate’ instead of ‘comfortable’? (I’d be wary of going down this route, especially if retiring early.)
Consider alternative assets
I’m sure it’d be appealing to have your investments work harder to take the strain, rather than you. Perhaps you could swap some of your fixed income allocation for infrastructure funds or renewable energy trusts? Yeah, maybe. The trouble is you’re often getting more equity-like volatility for potentially not hugely more return. By all means research and dabble with say 5-10% of your portfolio. But understand the trade-offs.
(Cautiously) chase yield
Similarly, government bonds from the developed economies aren’t the only fruit. You could add higher-yielding emerging market bonds, investment grade corporate bonds, junk bonds, and even preference shares. But again, you’re not getting something for nothing. At the least, swapping some safer bonds for riskier ones will mean deeper falls for your portfolio when the market dives – and potentially even permanent capital loss. Be careful.
Dabble with factor investing on the side
Academic research suggests certain kinds of shares deliver superior long-term returns, although for most of the so-called return premium [15] / factors there’s been little sign of that in recent years. The good news is an allocation to value stocks or a small cap fund is approved even for passive investors. See our articles [15]. The bad news is you don’t know whether your Smart Beta fund will actually lag the market over your investing lifetime.
Go to the dark side: active management
Well, well, well… fancy seeing you here [16]. Seriously, if you’re suddenly willing to pay a fund manager 1.5% to try to get back your missing 2%, I’d think again. Active investing is a zero sum game [17]. On average half of the people who go down this path will do worse – and there will be higher fees for all of them. As for stock picking, I do it but it’s not something to pick up because you like the sound of 10% a year. You’ve got to love the game, man! (Love it because the chances are you are going to lose at it.)
Live more uncomfortably, and do something hard
A wise man once said [18]: if you want easy money then do something hard. Buy-to-let [19] is a lot more hassle than owning a REIT, but you can employ an edge (find a better property), improve your investment (refurbish and remodel), and also gear up your returns (with a mortgage). That’s even more true of starting a business – or a time-sapping side hustle. You could strive for a higher salary [20] to save more. Or you could run equities at 100% and resolve to turn your computer off for 1-10 years if (/when) there’s a big bear market. Risky, but it is an option. Especially if you’re in your 20s or 30s. You’d be paying for any higher returns with more risk (equities might never come back) and more pain (you’ll stay up at night wondering if they will.)
Remember that nobody in those previous generations were gifted those pleasant returns, not even the Boomers. Many times your parents or grandparents felt their world might be ending.
You can never bank on [21] expected returns. That will never change.
Do-it-all
My co-blogger The Accumulator has explained how making adjustments [22] to the dials on your investing plan is a better strategy than simply quadrupling down on risk, say.
Do a bit of everything to make the numbers work. Save a little more, retire a little later, and hold a little bit more in shares.
But don’t just stick 12% into your calculations and pray because that’s the return you need to achieve.
Hope is not a strategy.2 [23]
If we assume we’ll see low returns in the future compared to those enjoyed by previous generations, we can at least take remedial action.
And if equities do deliver 5% real returns over your investing lifetime? Thus leaving you with a fatter-than-expected pot to live on?
I’m sure you won’t be asking for a refund.