This article takes a look takes a look at share price forecasts, expected returns, and what they might mean for your investment portfolio.
You don’t have to watch CNBC or Bloomberg very long before you come across some financial expert forecasting. =
But let’s get the elephant out of the room straight away. The fact of the matter is making market predictions is a dark art at the best of times.
Even the biggest names in the investing game struggle with it. This is according to research carried out by David Bailey, Jonathan Borwein, Amir Salehipour and Marcos Lopez de Prado.
Their study Evaluation and Ranking of Market Forecasters covered 6,627 market forecasts over a 20 year period from 1998 until 2012 from 68 recognized market forecasters.
The overall accuracy of these experts’ share price forecasts wasn’t good. In fact it was only 48%, so just about 50/50, or the equivalent of flipping a coin or guessing.
Even really trustworthy investment institutions like Vanguard need to make predictions now and again to satisfy their customers’ demands. However, Vanguard certainly don’t try to pull the wool over investors’ eyes when making any share price forecasts:
Our current view is that a 60% equity and 40% bond portfolio is most likely to provide a return between 2.2% and 7.5% for the ten years to December 2026. Yes, that’s a wide range, but it’s a reflection of how difficult forecasting is. The central point of this range is around 4.5%.
Vanguard
As Vanguard themselves freely admit, that’s a big range.
So if share price forecasts aren’t any good, and if nobody knows what returns we are going to get, how can we get any idea about what number we can assume for planning?
Investment returns
Lars Kroijer, in his book Investing Demystified, suggests some safe assumptions for long term real returns. 4-5% for stocks and 0.5% for short term or inflation protected government bonds.
This is pretty much in line with the Credit Suisse Global Investment Returns Yearbook. This is a publication that includes historic returns since 1900.
Their research shows global stocks returned 5.2% and long term global bonds returned 2%.
Based on the above I do not think it is crazy to make the following return assumptions. 4.5% for stocks, 0.5% for short term government bonds, 1% for medium term (or a mix of the three), and 2% for long term bonds.
Using these numbers, you can assume a traditional 60/40 portfolio containing global stocks and a mix of bonds would return about 2.9%.
That’s probably a lot lower figure than some people might be expecting, but you’ll still make money over the long term. Most importantly it emphasizes the importance of keeping fees low.
Fees
If you thought forecasting share prices were difficult, wait until you try fee forecasts! Determining exactly how much you pay for your investment funds can be just as difficult as forecasting the stock market.
Even though certain fees are provided, hidden costs such as turnover and performance fees might subtract substantial amounts from your returns.
The Money Advice Service gives the following typical annual charges for different investment types which you can use as a starting point:
- Actively managed funds (Unit Trusts / OEICs) 0.75% – 1.25%
- Tracker Funds 0.25% – 0.85%
- Investment Trusts 0.8% – 1.8%
On top of these costs, you might have to pay, entry and exit fees and costs, fund trading costs and stamp duty, performance fees, and advice fees with active funds.
Most trackers aren’t going to have these fees, and if they do they should be very low. On the other hand for active funds these fees can add up.
Take fund trading costs for example. In his book, The Little Book of Common Sense Investing, Jack Bogle estimates fund trading costs add 1% to your fees on average.
If we add this 1% to a 1.8% annual charge for an Investment Trust that gives us 2.8%. Subtracting that from our 2.9% expected return for a 60/40 portfolio, only leaves 0.1%.
That’s before we’ve even considered entry and exit fees and costs, performance fees and any advice fees.
Is it any wonder cheap passively managed index funds are gaining in popularity all the time?
If you can find a fund manager that you think will beat the market, then perhaps the higher fees may be worth it for you. (The evidence suggests this will be unlikely.)
Otherwise investing through cheap index funds is probably the best way forward for most investors.
The bottom line
So in the short term nobody knows where share prices are going, but over the long term we can assume the following for planning purposes.
4.5% for stocks, 0.5% for short term government bonds, 1% for medium term (or a mix of the three), and 2% for long term bonds.
That said, even this is a guesstimate.
Guesstimate or not, it does emphasize how important it is for most investors to keep fees low.
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