The bottom line:
The market environment has changed enormously over the last year. We expect much higher long-term returns in most asset classes and that’s impacting the portfolios we’re recommending to investors. Do you need to re-evaluate whether the risk you’re taking is still appropriate for what you’re trying to achieve?
Recent years have been tough on long-term investors. The world had settled into the low inflation, ultra-low interest rate norm. Yields on government bonds were low, zero or even negative, and as a result, future investment returns on a range of asset classes (which typically use the risk-free rate as a starting point) were low across the board and earning a decent return above inflation was difficult. We even wrote an article on what portfolio you’d have to invest in now to get the same return above inflation that you could earn from safe government bonds back in 2002. (Hint: it was 80% growth and 20% bonds).
The Quantitative Easing era meant that investors had to go much further up the risk curve to deliver the same outcome, or settle for less.
Things were particularly difficult for individuals saving for retirement. Most tools assumed a 7% pa return on your investments over the long return which wasn’t achievable without an extremely risky investment strategy.
The 2022 reset
2022 itself was an extremely tough year for investors with the value of stocks, bonds, real estate and other assets all falling. However, there’s a silver lining to these falls: it's likely that future expected returns have shot back up.
Fast forward to today: inflation is currently at 10.4% pa, interest rates are increasing, and expected returns have followed. Despite the economic environment being challenging, investors are now finding it much easier to construct a portfolio with expected returns significantly above expected inflation. We’ve calculated the expected return of some of our model portfolios now, vs 1 year ago and vs 10 years ago to show the massive difference we see now in the investment industry.
To calculate expected returns after fees, we have made a deduction of 1% pa to represent a typical private wealth investor's fees. This 1% might include asset management, platform and advisory costs.
Expected inflation is key to remember here. The market is pricing in a CPI assumption of around 3-4% pa, as opposed to the current inflation of around 10% pa. Clearly the outcome of inflation will have a huge impact on the real returns you’ll achieve with your portfolio. For our thoughts on the impact and future of inflation listen to our Investment Uncut podcast.
Disregarding inflation, each part of the portfolio is contributing to an increased expected return. In the section below you can click through the asset classes to understand how our expected returns have changed over time:
Let’s take a tour of some key asset classes and what this means for investors
It’s not just the market dynamics that impact return expectations. In its 2023 Yearbook, Credit Suisse reported on the real returns seen by Baby Boomers, Gen X, Millennials and Gen Z to highlight the different conditions generations have experienced. Humans ultimately still make investment decisions and are susceptible to bias, based on past experiences which can influence their views on the future.
Unprecedented events can change the investing landscape, and therefore adapting your portfolio is key to achieving the best results. It’s always a good idea to make your money work hard for you so ensure you’re getting the best risk/return ratio possible by investing in a good range of asset classes and considering new ideas when they come up.
2022 has delivered a complete reset to asset pricing, but don’t ignore the silver lining this brings for future returns, especially for investors contributing cash into their portfolio. You’ll want to reassess your allocations to make sure they remain on track for what you want to achieve. You might even be able to achieve the same outcome with less risk, in today’s new world.
Information in this article does not constitute legal, investment, financial or any other form of professional advice, nor a recommendation of a particular course of action.