Expected outcomes
‘It’s tough to make predictions, especially about the future.’
When building your financial plan, we look to calculate your future incomings and outgoings. Some outgoings – particularly those that sit out into the distant future – may require your assets to be invested into a portfolio consisting of stocks and bonds. Doing so increases the chance that your assets will be sufficient to meet the future liability, as we expect your portfolio to deliver a positive expected return over and above inflation over the medium to longer term. Simply holding these assets in cash, for example, could risk significant erosion of purchasing power and, ultimately, mean you may not be able to achieve your financial goals. Over the past 15 years cash has lost nearly a quarter of its purchasing power due to inflation in the UK.
Whilst we expect portfolio returns to be positive over the longer term, deriving a precise expected return figure we can be confident in can be somewhat of a futile task, due to the uncertainty involved in making such predictions.
We build what we call our ‘central case’ return assumptions using a logical framework, based on the premise that taking on sensible additional risks – such as owning an equity stake in companies around the world – is rewarded appropriately. Below are five important points to consider when thinking about expected portfolio returns:
1. Expected returns are simply the centre of a return distribution – they are not exact point estimates, but a starting point from which to consider alternative outcomes.
2. Returns do not come in straight-line averages, year-in, year-out – they come in more of a ‘two steps forward, one step back’, pattern. Over the past 30 calendar years, for example, the UK equity market has only returned within 5% of the average return on two occasions . The long-term is made up of a series of shorter terms.
3. Expected returns have no actual or implied guarantee – in all likelihood, an investor will experience an investment outcome that is different to the expected return.
4. Try not to get fixated on the ‘expected return’ number – don’t use such figures as a benchmark for portfolio performance, or as a means to estimate when your portfolio will reach a certain value, for the reasons mentioned above.
5. We meet with you regularly in order to navigate the changing tides – we, as your financial planner, will have a deep conversation with you about a range of possible outcomes and an insight into the actions that can be taken, if and when real life fails to follow the central case, as it most likely will. This helps provide you with the greatest chance of reaching each of your financial goals as and when they come to pass.
Recalling the points above enables investors to approach planning their financial goals, and to arrange their investments accordingly, with the necessary prudence and care.
‘Ignorance more frequently begets confidence than does knowledge.’ Charles Darwin
Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.
