4.3 Historic returns from different asset classes
Tables 4.2 and 4.3 summarise the historical evidence of returns from different types of investment ‘asset classes’.
Table 4.2 Average real annual returns for UK equities (shares), gilts (government bonds) and savings accounts
Table 4.3 Value at the end of 2015 of £100 invested at the end of 1899, with gross income reinvested
While evidence suggests that there is no guarantee that what has happened in the past will happen in the future, historical performance of products is still informative. Table 4.2 shows the average annual returns on UK equities, gilts and cash deposits for the periods 1899–2015 and 2005–2015. Note that when we talk about ’cash deposits’, these are investments whose returns are akin to those on bank or building society savings accounts. They are similar to cash in that they are liquid assets, and ‘cash deposits’ is the term that you will come across in this kind of product analysis in advanced personal finance literature. Note that the table is looking at a portfolio of equities – in this case the performance of the FTSE All Share Index, which includes around 1000 companies’ shares listed on the London Stock Exchange. Note also that the table shows real returns – in other words, the return over and above the amount needed simply to keep pace with inflation in order to maintain the buying power of the capital.
Table 4.2 shows that, over both periods, a diversified portfolio of equities outperformed gilts, which in turn outperformed cash deposits on a yearly returns basis. This outperformance is reinforced by the data in the second table on the value at the end of 2015 of £100 invested at the end of 1899.
Compounded over a number of years, the differences in annual average returns between equities, bonds and cash can make a huge difference in money terms.
If investing in shares makes higher returns, why don’t people put all of their money in UK equities rather than in gilts or cash? One point to bear in mind is that such returns are only an average on a portfolio of shares, achieved over the period shown in the table. The actual return on a portfolio of shares in any one year has ranged from a staggering −51.7% (the loss of more than half of the capital) in 1975 to a rebound the following year of a 150.9% gain!
A person’s attitude to investment risk will determine how much someone invests in equities (shares), in bonds and in cash (or savings products). If someone is highly risk averse, they are more likely to stick to savings products and bonds – although the evidence here shows that they will be likely to lose out over the medium to long term by being under-invested in shares. If someone is less risk averse, they will be happy to focus more on shares when it comes to the composition of their investment portfolio – provided their investment time horizon is not too short.