Did you know that you should expect equity investments in the UK or US to return only about 5-6% each year. Surely not you say, what about the recent very high returns from the early eighties until recently. Well, I'm afraid they were mostly an illusion. Sure, they happened, but my point is don't expect them to be repeated anytime soon.
Over time, equity investments can only deliver returns based on increases in a countries Nominal GDP, for if they returned more, then they would be making more and more profit. Fine you say, what's the problem with that, but let me tell you the profit they make is at your expense. Yes, that's right. You see, it's like a pie, and each 'thing' that produces gets a share of that pie. Now, GDP is the pie, while companies, people and resources like raw materials and land are the slices.
So, what about those recent high returning years? Well, as I said, it is an illusion to think they are repeatable anytime soon. Since the early 80's, a number of elements combined together which re-rated investors perceptions of value. For example, interest rates fell. And as investors received lower and lower yields on cash and bonds, so they switched into equities and boosted their price. Of course, here in January 2009, interest rates and yields are very low; you don't need me to tell you which way they go next. There were other effects as well, but we will leave those for time.
So, if equity investments really do produce such low returns in the long-run, what does this mean for you retirement portfolio? There is very little good news I'm afraid. Firstly, I suspect that a return of 5-6% over the next few years is optimistic. Excesses of the past ten years or so need to be unwound, and some of the 'secular' elements I described above will reverse. Investors need to reappraise their portfolio and retirement planning in the light of a less rosy future and consider selling equities into any 2009Q1 rally.
Disclaimer: This Essay is a personal opinion and does not constitute investment advice
Richard Noble
http://moneydelusion.blogspot.com/
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