Return expectations – 2020 edition

How much can a UK-based investor expect to make on their investments over the next 10 years?

To help answer the question, I’ve collated 10-year equity return forecasts from as many different (reliable) sources as I could find – 13 in total. As with most things investing-related, the data was heavily US-biased and almost always in dollars. To make the returns useful for UK-based investors, I’ve adjusted the forecasts to be relevant for sterling-based investors investing in a global equity portfolio.

As well as providing data for 10-year returns in this post, I’ve also included a section for long-term return expectations, based on data going back to 1870. For those with a multi-decade time horizon, this gives an indicator of what returns equity investors might receive over the much longer term.

For those interested in seeing the underlying data, I’ve included links to all data sources in the ‘Data’ section. For details of all calculations I’ve made, refer to the ‘Methodology’ section.

How reliable are 10-year return forecasts?

Before getting to the numbers, it’s worth thinking about the reliability of returns forecasts.

Although equity returns are completely unpredictable over the short term, in the medium term (around 10 years), returns become increasingly predictable as they become a function of starting valuations. Expensive markets with high valuations tend to have lower returns over the next 10 years, and cheaper markets with lower valuations tend to have higher returns.

While many investment forecasts have little-to-no evidence to support them, there’s enough evidence behind the relationship between starting valuations and subsequent 10-year returns for it to be worth considering. The details of the evidence will be the subject of a later (probably multi-part) post, but it’s worth remembering that the relationship is far from perfect. Not only is there considerable variation around the expected return estimates, but attempting to use country/regional valuations as a means of market timing has proved to be futile by many professionals (this will also be the subject of a later post).

What these return expectations are useful for is giving a good ballpark idea of whether returns are likely to be higher or lower than we’ve seen in the past. They can serve as a useful starting point for setting expectations around the returns your investments are likely to generate. 

To demonstrate the uncertainty around the return forecasts, I’ve presented them in quartiles below. While these results can be useful for setting expectations, they are still highly uncertain.

10-year return expectations

Sources: Refer to ‘Data’ section

• Due to high global valuations, expected returns for the next 10 years are lower than they’ve been in the past. UK investors can expect around 5% nominal returns over the next 10 years, on average.

• The range of expected returns is wide. Estimations for the median return for global equities range from 0.1% (GMO) to 5.7% (Morgan Stanley and BNY Mellon).

• For the differences between minimum and maximum expected returns, Star Capital forecasts the lowest minimum return at -2.5% and also the highest maximum return at 12.4% (NB: these results aren’t on the chart due to only the median quartile results being shown).

• Of the global equity regions (US, Europe, Emerging Markets), the US and Europe show similar expected returns. Emerging markets are likely to produce higher returns, although this comes with higher risk.

• Sterling is predicted to strengthen by an average of around 15% versus the US dollar over the next 10 years. (NB: Although currencies are notoriously difficult to predict with any form of accuracy, they have shown a tendency to mean-revert over long time periods, such that long-term returns for currencies are approximately zero. However, this currency prediction is the one I’m least confident in.)

Long-term return expectations

• For multi-decade forecast horizons, the impact of starting valuations is diluted, so long-term historical average returns may matter more in setting expectations.

• Over the very long-term, using one data source from 1870 and one from 1900, long-term real returns for equities are in the region of 5.5% – 7%.

• This is the same regardless of currency, as the data since 1900 does a good job of showing that purchasing power parity holds over the very long term.

My thoughts

• Expected returns are much lower today than the historical average. While it’s not particularly fun to be living in a low-return environment, investors should be adjusting their expectations to assume lower returns over the next 10 years.

• We saw in this post how our returns are determined by three things: Risk, Time, and Fees. The returns stated here are for those who invest in a 100% equity portfolio (high risk), over the next 10 years, before fees. The first two factors are fixed, but the third is up to the investor – we all choose how much we pay for our investments. This is an especially important point, as during times when we have low expected returns – as we do now – fees become a heavier drag on returns. A 2% fee eats proportionately more of your return when you’re only generating 5% a year (fees eat 40% of your returns) than if you were generating 9% (fees eat 22% of your returns). It’s in these low-return environments when fees really do matter.

• It might be tempting to look at the expected returns from equities and think you can do better elsewhere. Many professionals are doing exactly this – private equity, venture capital, hedge funds – all tempting alternatives to traditional public equities. But by trying to capture this higher return, investors move up the risk spectrum, and away from their appropriate level of risk. Basic investing theory tells us that our returns should be determined by the levels of risk we’re willing to take, meaning we get the returns that we’re given based on our risk tolerance – we don’t get returns because we want them really badly. The market doesn’t care what returns you need. Our returns should vary around a given risk tolerance – our risk tolerance shouldn’t vary around a given level of return. That makes no sense. We should accept that we’ll receive what the market gives us, and not become fixated on chasing ‘target returns’. The siren song of higher returns coaxes us into taking on more risk, which can have disastrous consequences further down the line when that higher risk manifests itself in the form of a selloff. Ultimately, the most important determinant of our future returns is outside of our control anyway – when we’re born.

Methodology

Methodology for calculating 10 year expected returns:

• Returns from all sources were converted to a global equity return – weighting US, non-US, and EM returns by MSCI ACWI weights where a general ‘global equity’ return wasn’t provided.

• All real returns were adjusted to nominal returns by adding back any assumed inflation.

• Non-sterling returns were converted to GBP where only USD returns were given, using an average conversion rate backed out from sources where comparable USD and GBP returns were given.

• Each estimated quartile return was calculated by taking the median quartile returns of all sources (NB: not all sources provided data by quartile).

Data

Data for 10-year returns:

Data for long-term real returns: