Ian Thomas, Pilot Fiancial Planning
A better rate of return without risk?
One of the questions I’m most frequently asked at the moment is: ‘where can I get a decent rate of return on my investments, without taking too much risk?’
Before you read on too much further, I should probably warn you at this point that there are no simple answers; a ‘silver bullet’ doesn’t exist which can solve the concurrent problems of high inflation, low interest rates, falling property prices, government debt defaults and extremely volatile stockmarkets. What I can offer, however, is my perspective on the current situation and some high-level thoughts on how to approach the challenge.
Let’s look first at cash, the ‘safest’ investment option. Interest rates on bank and building society accounts fluctuate considerably, but over the long-run have averaged around 4% (net of basic rate tax); unfortunately, inflation has averaged 5.6%*. This means that by not being prepared to risk any short-term loss to their capital, investors have paradoxically seen the real value of their savings fall over time. With the best instant access savings accounts offering around 3% at the moment and retail price inflation running at just over 5%, the current negative rates of real return are actually not so unusual in a historical context.
This sort of slow motion robbery means that if you’re looking to maintain the spending power of your capital over many years, your local bank probably isn’t (and never has been) the answer. Despite this, for any shorter-term needs cash is still the only sensible investment option. If you don’t need instant access then fixed-term deposits or even inflation-linked accounts can help improve returns and it pays to shop around on a regular basis; rates change frequently and many of the best deals are only available online. Also, don’t forget to keep your balance with any one banking group below the current Financial Services Compensation Scheme limit of £85,000.
For any longer-term investments, the stockmarket has generally offered much better rates of return, but with significantly higher volatility. Looking at UK shares’ performance, the best return over a 12 month period was over 150% (from January 1975), whereas the worst was -55% (in 1974). Over time however, these ups and downs tend to balance out, and over any given 20 year period the average return has never been lower than 7% per annum**.
For anyone who is now thinking that a strategy of simply avoiding the bad periods and joining in during the good times is the obvious answer, consider this: since 1986 the average return on shares has been over 10% each year, but if you’d missed only the best 25 days in these last 25 years the average return would have fallen to under 5% per annum! When financial markets adjust (up or down), they tend to do so very quickly; these movements are also virtually impossible to predict in advance, despite what many ‘experts’ would have us believe.
As a result, the vast majority of professional investment managers have not succeeded in consistently out-performing through active management strategies. And private investors have generally fared even worse, typically buying into the latest ‘hot’ sector, or top-rated fund, at or near its peak, and then selling again after the market has fallen. A simple buy and hold strategy, keeping costs to an absolute minimum is, in my view, the key to investment success.
Even so, the risk of investing everything in the stockmarket remains higher than most people are comfortable with. They might want to eat well in the future, but they have to sleep well in the meantime! Fortunately, although there are never any guarantees, there is now a well-established ‘science’ of investing which shows us how, by constructing a very well-diversified portfolio, across a number of different types of investments, it is generally possible to achieve excellent returns whilst keeping losses to a minimum. An investment strategy for all seasons, if you like. Structure the portfolio correctly to minimise income, capital gains and inheritance taxes too and you’ll be well on the way to achieving the goal of a solid return at an acceptable level of risk.
Sources:
*Barclays Equity Gilt Study 2011 1956 - 2010.
**Dimensional Fund Advisors, Jan. 1970 – Sept. 2011.
Contact Ian Thomas at Pilot Financial Planning:
08453 712 808, ian@pilotfinancialplanning.co.uk
www.pilotfinancialplanning.co.uk
Pilot Financial Planning is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.
First Published December 2011 By The Dart