How Much Return?

Your expectation of returns underpins your judgement of where to invest, how much risk to undertake and how much to pay for product management

If you can answer these questions it will help you make more informed judgements about your savings strategy:-

  • If you invest in equities, what return are you expecting?

  • If you invest in corporate bonds, what return are you expecting?

  • If you invest in gilts, what return are you expecting?

Homework

You may want to refresh your memory about the difference between 'real' and 'nominal' (or 'money') returns. See 'Real Returns '.

Also understand the principle of the trade-off between risk and return. It is convenient to think of the return on a particular investment as the sum of a risk-free return and a risk premium. The return on government bonds ('gilts') is usually taken as the risk free return. High risk investments attract high risk premiums. See 'Risk Premiums'.

What about the future?

Well, who knows? Any projections about the future are hazardous. Any statements about the past are complicated because ‘answers’ depend on which period of which length is chosen.

However we think you have to have a handle into the subject, or a ‘typical set of numbers’, to give you a basis for talking with your friends and advisers and help you make the decisions you have to make on spending and investment.

So, the table below is not a forecast. Nor is it a historical statement about any period in the past. It’s to give you a common start point for thinking and learning and gaining some insight on expectations. And that is to help you make asset allocation decisions. How much extra return can you expect for spending less or taking on extra risk, and is it worth it to you?

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Product charges and risk premiums

The table shows a forecast equity risk premium is 3.5% per annum. That may seem small, but you know what a big difference compounding makes.

Now:

  • if your personal savings comprise investment products, and

  • you are paying the odd % to a fund manager here and the odd % to a wrap manager there and the odd % to an adviser somewhere else, and

  • each of those gentlemen is paying brokers and other middlemen in ways you may never see because it comes out of your fund returns,

.........then it does not take too long for these costs to get to 3 or 4%, which is the equity risk premium.

In which case, why bother with the products?

More generally, the level of charges in a financial product needs to be sensible relative to the risk premiums of the investments underlying the product.