It’s funny, 10% is a magic number. It’s a number that sounds realistic. Trying to make 50% on your investments sounds great but most people realise its unlikely. 10% however, sounds doable. But is it?
Here is a scenario. You have £1,000,000. It is made up of £100,000 in cash and a 60/40 portfolio of equities (£540,000) and bonds (£360,000).
10% would mean at the end of the year, you have £1,100,000. That’s the target.
In the real world, cash might give you 1%. Bonds 2%. So, based on mathematics, equities will need to grow by 17%. Is that likely in one year? Possibly. Is it likely every year? Very unlikely. But anything less than 17% in equities means you fail to achieve your target of £1,100,000. In fact, a more realistic target for equities is 7%. Of course, that’s just an assumption.
Even if 10% was possible, that is not gross. You’ll need to add in fees and intermediation costs. You will also need to take into account tax. So to get 10%, your wealth managers may need to grow your money in excess of 13% each year, so you can end up with 10%. So based on the 60/40 portfolio above, your wealth managers will probably need to earn over 20% in equities, just to get your close to your 17%! Now that is unlikely, year in year out.
The simple facts are that your net worth is unlikely to grow by 10% each year.
You may change your expectations. What about 6% instead of 10%? But based on 60/40 portfolio the gross return on equities probably needs to be around 12%. Is that likely year in year out?
The maths tells you stories you may not want to hear. It is nevertheless useful to understand the maths. If you do, you are more likely to make better investment decisions.