We will have to save far more as investment returns dwindle

Allister Heath
IF you have savings, which asset class you choose to allocate your wealth to is one of the most important decisions you will ever make. It is vital to look at very long-term returns, and there is no better place to find this information than Credit Suisse’s global investment returns yearbook, published today.

Over the last 113 years, the real value of UK equities, with dividends reinvested, grew by a factor of 316.0, compared to 5.5 for bonds and 2.9 for bills. In other words, the very long-term performance of equities – not just their capital gains or indice values, but crucially with reinvested income – is gigantically superior. Another way to look at the figures is annualised real returns: equities delivered 5.2 per cent a year, bonds 1.5 per cent, and bills 0.9 per cent since 1900.

The problem with these figures, however, is that nobody has a 113-year investment horizon. Even multi-decade periods can vary substantially from these very long-run outcomes, an issue for real world investors. Investors who buy and sell at the worst times will massively underperform. Wall Street suffered a real capital loss of 67 per cent in 1929-32, followed by a huge rebound of 50 per cent in 1933. It suffered a real capital loss of 39 per cent in 2008, followed by a 23 per cent rebound in 2009. In Britain, there was a real capital loss of 36 per cent in 1920, then a gain of 75 per cent in 1921-22. The 1970s were crazy: UK equities collapsed 74 per cent in real terms in 1973-74, before surging 86 per cent in 1975.

It is clear that the world today – and probably for the next few decades – will be very different to what we have seen in recent decades. From 1950 to date, the real return on world equities was 6.8 per cent per year; from 1980, it was 6.4 per cent. The world bond returns were 3.7 per cent and 6.4 per cent, far higher than normal in the last 33 years. We have just come out of a period of exceptionally high returns for many asset classes: even cash gave a high real return, averaging 2.7 per cent per year since 1980, far more than in previous decades.

Perhaps most interestingly of all, the Credit Suisse data shows how savagely equity investors have been hammered in recent years. Over the first 13 years of the 21st century, the real return on the world equity index was just 0.1 per cent per year. Real bond returns stayed extraordinarily high at 6.1 per cent per year – but the long bull market in bonds, which started in 1982, is now over, in a dramatic and hugely important shift.

The research’s conclusions are depressing. The high returns made from stock market investments in the second half of the 20th century were abnormal; the same is true of the high bond markets returns made of the last 30 years and the high inflation-adjusted interest rates since 1980. The future will be one of much lower returns. Credit Suisse estimates that over the next three decades, global investors can expect to earn a real return of a maximum of 3.5 per cent a year on an all-equity fund.

Assume a 25-year old entering a defined contribution pension scheme with the hope of retiring at 65 on half their salary. If the after-costs real investment return is 4 per cent, they will need to contribute 10 per cent of their salary. A more realistic assumption is that the after-costs real return will now be 1-2 per cent. This requires a contribution rate of a crippling

16-20 per cent, the authors calculate – and that is if they start at the age of 25. If they start any later, then the percentage will be much higher.

Who do you know saves a quarter or a third of their salary for their pension? A horrible crisis is looming, caused by low returns, one worse than almost anybody realises.