What Returns Can You Expect Investing in Stocks and Shares – The 4 Key Guiding Factors
Wondering what kind of return you may achieve investing in the stock market (and things similar to this) is something we find a lot of people want to know when considering investing. As you may expect, the answer is….it depends. Depends on what?
Well, if you look at the Credit Suisse Yearbook (which is basically a summary of returns on lots of different things in different parts of the world over the last 120 years), you can see long running returns in the financial markets(1). This includes equities, which are a small slice of ownership in a big company. It also includes corporate and government bonds, think what the likes of the UK government or Sainsburys might use to borrow money to fund things such as surviving a pandemic, which they then pay interest on and ultimately pay back.
The 2020 Credit Suisse Yearbook shows that over the last 120 years, equities have comfortably outperformed everything else, delivering 9.6% p.a. on average, almost double bonds (and way ahead of cash!). By that logic you would think should just put all your money in equities right? …there is more to it than that.
The return you can get when investing in an asset is directly linked to how much risk is involved. UK government bonds for example are deemed virtually risk free, given it is the government after all, and as they are demonstrating just now, more money can just be printed via the Bank of England to give back to you. But returns on these are virtually zero because interest rates are so low. Conversely, equities in more developing parts of the world can provide stellar returns, but can easily lose you just as much, given these countries can be less stable, and legal rights for foreign investors aren’t always very robust.
But if we leave aside specific types of asset for second, experience tells us the following are the main factors that you actually need to take into account when considering investing in stocks and shares, which in turn dictate what you could hope for in returns:
1) Why are you investing in the first place – What if just making as much money as possible isn’t your aim, as we often find, more money is rarely what people are really investing for, when pushed. It may be to be able to work 3 rather than 5 days a week, buy a holiday home, pre-fund school fees…whatever it is. We would encourage you to think about this clearly, because rather than chasing a bigger and bigger number which is ultimately rarely ever enough, have a tangible object, event, or lifestyle which gives your money more meaning.
2) What do you need to make – If you now understand why you are investing, you need to quantify this, for example, which boat it is you want to buy and the running costs. If once you are clear on what is required from a monetary sense, and you only need returns of 5% p.a. (definitely above cash, but less than equities), do you need to just invest in equities and swallow more risk? Combining a diverse range of equities, with the right amount of lower risk things like bonds, can get the returns needed, without as many of the ups and downs along the way.
3) When do you need it – Contrary to normal life, what will happen in stock markets tomorrow, next week, next month, is impossible to predict. But the farther into the future you go, the outcome becomes more reliable. In turn, this means the longer someone is invested, the impact of investing at a very unfortunate time (March 2000 (dotcom crash), September 2008 (Global Financial Crash), February 2020 (Covid – 19 pandemic)) is much less of a problem. So to relate this to when you need your money for that boat, if you don’t expect to buy it for 15 years, rather than 5 years, you can afford to take more risk. This is because you could be confronted by a significant event, but still have plenty time to recover and experience good returns. Conversely, if you are only investing for 5 years, you have less time, so you want to ensure you take less risk and experience less of the brunt of stock market fluctuations.
4) How much can you afford for your investment to drop in value – the most extreme examples of wealth are those that have the vast majority in one single thing / place (Jeff Bezos in Amazon shares, Bill Gates in Microsoft shares, Elon Musk in Tesla shares, and so on). But to take this example of extreme concentration, it works the other way, such as the unfortunate investors or employees who were invested heavily in the Royal Bank of Scotland in 2008.
So if more money / optimal returns really is the only objective, that need for results pushes people to chase returns over a much shorter period (because we aren’t the most patient of creatures!), and to take excessively big bets in the process. This is called Present Bias, where effectively we value our short term gratification, over longer term objectives /our future selves.
If this is the case, you should only invest this way with what they can genuinely afford to lose. Because with maximum possible returns, comes maximum possible loss. By working through the first three points properly, you will hopefully begin to understand what this amount is.
By walking through each of these steps you will begin to understand that, from afar, although maximising possible returns seems like the only aim anyone should have when investing in stocks and shares….there should be more to it than that, and in turn a better feel of what return you could and should expect.
(1) Summary Edition Credit Suisse Global Investment Returns Yearbook 2020