Uncertainty is a certainty
There is a big question doing the rounds of financial adviser circles: should we expect lower investment returns over the coming years?
This is a big question not just for investors and KiwiSavers, but ultimately it becomes a public policy issue as well: lower investment returns will mean that people will have saved less for their retirements and, in retirement, will have less money to live on.
Long-term lower investment returns could have a big impact on the economy and people's lives, as well as government policy.
When making a financial plan, financial planners have to make assumptions on what investment returns are going to be - you simply cannot plan how much money someone will have and how their lives will be in retirement if you do not do this.
However, it is difficult: how do you predict the returns on bonds, shares, cash deposits and property? That is hard enough but bear in mind, to make a long-term investment plan, you may be making your predictions for investment returns for 10, 20 or even 30 years. Moreover, a small inaccuracy can make a big difference - just 1 per cent lower returns can see much less for retirement.
Many financial advisers would now say that long-term investment returns are likely to be lower: the GFC and the ongoing economic problems in Europe and the US mean that we cannot be as optimistic as we once were. Expectations need to be lowered, some would say, and financial plans adjusted accordingly.
The only way that you can try to predict future returns is to look at what has happened in the past. Although it is no guarantee of future returns, the past is the best indicator that we have. For example, if you measure the returns from shares over the past 100 years you may find that they have given total returns of 10 per cent a year over that time.
In the past, most financial advisers would, therefore, assume that future returns are likely to be much the same.
This seems to me to be reasonable - after all, when measuring returns for shares over the last 100 years we know that shares have faced just about everything that they are likely to face in the future: booms, busts, depressions, technological breakthroughs, financial crises, natural disasters, wars, pandemics and so forth. These will happen in the next 100 years just as they have in the past and, therefore, investment returns should be similar.
However, although this is statistically probable over the next 100 years, few of us are investing for as long as that: we may be investing for 30 years (perhaps even a bit longer) but only a few institutional investors are in the game for longer than that.
The longer that you are investing for, the more likely your returns will be the same as investment returns in the past. However, over the short term, past returns cannot be relied on: instead of giving a 10 per cent return as expected, shares in the next five years may give returns of +20 per cent a year or -20 per cent. We just do not know.
This makes it difficult for investors and their advisers - you cannot have any certainty about short-term returns from shares, or any other investment class, for that matter. We could think that for the next five years share returns will be low because of the continuing global economic difficulties, and maybe we would be right. However, that does not mean that the retirement savings that we have, and which are invested for the next 20 years, will be much affected.
Although I am not sure what will happen in the short term, I can be fairly sure that over the long term, investment returns will be much the same as they have been. There could be some major event that is a game-changer (either on the upside or the downside) but for long-term savings and investments, I am not going to lower expectations but will stick to using the returns that we have had over the past 100 years.
This may be hard for a while as investments will be volatile, but eventually returns will revert to the historical norm. It may not happen overnight, but it will happen: over time, I think that investments will continue to do about what they have always done.
Martin Hawes is an authorised financial adviser and his disclosure statement is available free of charge at www.martinhawes.com. This article is of a general nature and no substitute for personalised financial advice.
Sunday Star Times