"What investment return can I expect?"

People often ask me what sort of return they can expect from their investments.

I would love to give them a straight answer.

(The bigger the number, the better! I wish I had the confidence - audacity, really - of Dave Ramsay, who tells people to anticipate a return of 12% on investments. Not adjusted for inflation, of course.)

Unfortunately, unless someone is invested in a simple term deposit with an explicit return, I can't honestly give a figure and let that be that.

Even with term deposits, the actual return will depend on inflation, which can change over time.

Consider the following chart, from the terrific website FIRECalc:

Firecalc - 1m, no exp, 50-50 equities-fixed interest.png

This chart represents the returns of a 117 different $1 million portfolios with no withdrawals over the course of 30 years. Each line represents historical outcomes for the same portfolio (to the extent possible), with an allocation of 50% each between equities and fixed interest. 

The only difference between each of the 117 portfolios? When the portfolio began. Ie, one of those lines relates to a 30 year period starting in 1900. One relates to a period starting in 1929. One in 1967. 1980. Etc.  

FIREcalc shows historical returns dating back to 1871. Some caveats: it's US-focused. And of course, historical returns are no guarantee of future returns.

But despite these qualifications, this graph illustrates something we need to take to heart: we just can't know ahead of time how investments will perform.

I wish I could predict returns. I wish I could provide certainty.

I wish I could be able to pick which line an investment portfolio will follow. But I can't. I don't think anyone can. And to tell anyone otherwise is a disservice.

If someone says they can tell you what you'll get - well, good luck to them. I think it reveals more about that person than what the future actually holds.

Some people might suggest that this is the case, but if you look at the averages and standard deviations of returns, you can model different scenarios of what might happen, for example with a monte carlo simulation.

This is better than taking a specific figure, but it still has its limitations. For example, it generally assumes that investment returns are normally distributed. This is a big assumption, and not, to my mind, a convincing one. 

Having said all this, there are things that I can say with confidence (if not absolute certainty).

For example, that investing in equities has historically generated higher returns than fixed interest over the long-run, albeit with more ups and downs (volatility). It makes sense that this trend will continue into the future.

And especially if you're retired and will need to rely on your capital to support your lifestyle - it's important to review your returns regularly and calibrate your lifestyle expenses to how your investments are performing.

This works both ways - whether you're not generating the return you expected, or whether you're generating better-than-expected returns. In the latter scenario, you might want to increase your expenditure, unless you want your children to fly first-class once you're gone.

A couple of graphs illustrating this are below.

The following chart illustrates the same scenario as above, but with a portfolio consisting entirely of fixed interest products. Pay attention to the vertical axis relative to the other graphs. Note the highest balance at the end of 30 years is $4,902,867.

Firecalc - 1m, no exp, 0-100 equities-fixed interest.png

The following chart relates to the same scenario, but with a portfolio consisting entirely of equities. Pay attention to the vertical axis figures. Note the highest balance at the end of 30 years is $15,852,374.

Firecalc - 1m, no exp, 100-0 equities-fixed interest.png

When people ask me what sort of investment return they can expect, I wish I could give them an exact response! But the only way I'd be able to answer accurately is with hindsight. And unfortunately, I don't have a time machine that lets me go into the future. 

(If anyone has a time machine, let me know!)

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Sonnie Bailey

Sonnie is the founder and principal of Fairhaven Wealth.

Before founding Fairhaven Wealth, Sonnie worked in the legal and financial services industries for over a decade.

Sonnie first became involved with financial advice as a specialist financial services lawyer. For many years, he was an “adviser of advisers”, reviewing thousands of advice files prepared by hundreds of financial advisers, and providing feedback in relation to the quality and appropriateness of advice; industry best practice; risk management; and regulatory compliance. He has published work in industry publications and spoken at various financial advice conferences.

Sonnie has also worked with banks, investment management firms, insurers, and derivatives providers.

Sonnie has worked as a private client lawyer, focusing on succession, estate planning and trusts. He ran his own legal firm in Australia before relocating to New Zealand. He has also acted in independent trustee and company director positions.

Sonnie is passionate about helping people achieve their goals and manage the risks to which they are exposed.

He has written extensively on his blog, New Zealand Wealth and Risk, which can be found at www.wealthandrisk.nz.

Sonnie is married to his wonderful wife Chrissy, and has two young children, Ben and Anna.