Why would anyone take that type of risk? Imagine watching the steam roller heading towards you whilst picking up pennies. It seems crazy.
What pennies are we talking about? Fixed interest investments.
Let’s start with the basics. You have £1,000,000 invested. The portfolio is 60/40 in favour of equities. If we assume the expected return on equities is 10% and bonds 5%. After 12 months, your portfolio is valued at (£600,000 x 10% + £400,000 x 5%) £1,080,000 before costs. According to the research the average retail investor portfolio costs at about 2.5%. So the gross return of 8%, now falls to 5.5%.
If we take future expected returns, equities 7.8% and -1% in bonds, what happens to the portfolio? After 12 months the portfolio is valued at £1,042,800. Less 2.5% costs, that’s a return of 1.78%. Now compound this return. How does your future capital look?
Whilst we have no idea about future actual returns, it is clear equities are expected to generate positive returns. However, bonds may not.
If the negative return on bonds is added to the costs, that means -3.5% to hold bonds.
Your portfolio may not even pick up pennies!
Of course, that’s rubbish. Investors say they are not charged average costs. That may or may not be true, but imagine if financial intermediation costs to include the OCF (ongoing charges figure) were only 1%, (I am being generous here) the expected return is still negative to hold bonds.
In other words, investing £400,000 with the possibility of minimal or even negative returns could happen. Why bother?
The question to your investment managers or wealth managers is…can they justify allocating your capital in assets that may not reward you for the risk? Are you prepared to accept losses on part of your portfolio?
Do you know about this problem? If not, why not, as it’s your money?
Investors first need to understand the risk they are taking before they can decide what action to take.
Want to see the assumptions? Click here