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There are many oddities in how we think about our finances. Returns are one elephant trap. They are the only meaningful output from investment. But most of us, I suspect, put little effort into assessing them.
The income we generate through work resembles a high-profile tennis match in which we contest and count every point. Personal investment, by comparison, is often a knockabout in which we lose track of the score.
This is a good time for UK investors to think harder about returns. A new tax year has just begun. Investment into personal pensions and individual savings accounts tends to peak in March and April. Laggards race for the deadline. Early birds hop in immediately afterwards to shelter fresh cash.
It is convenient to invest lump sums. It allows you to cross off “invest spare capital” from your to-do list. But it can play merry hell with returns.
I have just been reminded of this. Last autumn I ignored my own advice to trickle money in and out. I added to Baskerville Global Opportunities in one go with a proportionately large sum.
A superstitious person would argue that I erred by naming my main Isa account after a dog. But it had been doing well until I increased it heftily near a market peak. The US is my largest geographic exposure. The S&P 500 has dropped about 12 per cent since last autumn. I also have a chunk of UK equities. These have gone nowhere.
I am painfully reminded of the results when I look at my account summary on the Fidelity Investments execution-only platform, where Baskerville cowers, whimpering piteously. The company has posted a notice there, the gist of which is: “Don’t panic!”
“It’s a shock when you find returns have shrunk,” says Andrew Oxlade, a director at Fidelity, “it can trigger counter-productive responses.”
Other services are available, I should add. They include Hargreaves Lansdown and Scottish Widows, whose collective prestige I also lower with my patronage.
Fidelity gives me an upfront return figure adjusted in two essential ways after costs.
First, the return is annualised. This means payouts from shares and bonds are deemed to have been reinvested to generate further investment returns. This involves compounding. Annualised returns are therefore lower than the simple average annual return and a more accurate measure for the longer-term, buy-and-hold investor.
Second, the number is money weighted. Returns reflect the differing size of investments at different times. They record losses on unrewarding assets the investor has sold. Fund managers have been known to avoid this level of radical honesty by excluding defunct funds from advertised returns.
Fidelity does not tell me two additional things I like to know. But the information is easily obtained.
One is the impact of inflation. “What matters is your spending power,” says Paul Marsh, Emeritus Professor of Finance at the London Business School. UK consumer price inflation has compounded at just over 3 per cent yearly in the past decade, Bank of England data shows. That is a useful yardstick if you are UK-based. I am no longer as far ahead of it as I would like.
The second piece of missing information is the risk-free rate. If you favour risky equities, you need to know whether that boosted or bashed your returns. For comparisons, Marsh recommends annualised returns on Treasury bills, short-term government debt instruments. Over the very long term, these have beaten inflation by just 1 per cent a year in the UK.
To assess our returns in line with the four factors listed above, we must first clear a psychological hurdle. All four are liable to reduce the headline returns figure. This leaves it deflated. Which is also how we may feel.
What normality might look like is expressed in annualised, inflation-adjusted terms in the UBS Global Investment Returns Yearbook, which Marsh authors with two other experts. Since 1900, UK equities have generated average annual returns of 5.4 per cent compared with 1.4 per cent for bonds. The figures for the US are 6.6 per cent and 1.6 per cent, respectively.
Most of us spread our money across both asset classes. Useful blended return figures are provided by the Compendium of Investment from Sarasin & Partners, an investment manager to charities and wealthy individuals. These suggest a diversified portfolio including shares, bonds and alternatives, would have produced average, annualised real returns of 4.6 per cent in the 10 years to the end of 2023 and 3.3 per cent over 25 years.
Studying investment returns over extended periods encourages a person to think ahead. Sarasin senior partner Richard Maitland cautions: “Never invest in line with an equity-rich model if your time horizon is less than five years.”
He points out the snag in the common assumption that peaks and troughs in equities markets should smooth out over convenient periods. I have always assumed “long term” means five years or more. To Maitland, the description only applies to a decade or more.
That leaves us older members of the community with a problem. Time, the great healer, should eventually repair prior and prospective damage to our investments from current asset price reversals. But time is something we have less of as we age.
Previously I sneered at the longevity aspirations of tech billionaires. I may now need a few extra decades myself, simply to bring my investment returns back up to a respectable adjusted average.
If any reader has conducted a cost/benefit analysis on having their head cryogenically frozen, please share.
Jonathan Guthrie is a writer, an adviser and a former head of Lex; jonathanbuchananguthrie@gmail.com
