Expected returns: Estimates for your investment planning
With a credible expected return figure you can work out whether you’re investing enough money to meet your goals – just by plugging your number into an investment calculator.
Give us a few minutes and we’ll show you how it’s done.
What are expected returns?
Expected returns are estimates of the future performance of individual investments – typically asset classes. Expected return figures are provided as average annual returns that you might see over a particular timeframe. Say the next five or ten years.
The figures are usually based on historical data, but modified by current valuation metrics.
The Gordon Equation is the best known expected returns formula.
Because future returns are highly uncertain, some sources offer a range of expected returns or probabilities. This emphasises the impossibility of precise predictions.
Think of expected returns as a bit like a long-range weather forecast. You’ll get some guidance on conditions coming down the line. But expected returns can’t tell you when exactly it will rain.
Even so, expected returns are a useful stand-in for the ‘rate of return’ required by investment calculators and retirement calculators.
By collating estimates for individual asset classes, we can calculate a portfolio’s expected return. See the table below.
Moreover, because expected return calculations are informed by current market valuations, they may be a better guide to the next decade than historical data based solely on past conditions.
Expected returns: ten-year predictions
|Asset class / Source||Vanguard (30/9/22)||Research Affiliates (31/12/22)||BlackRock (30/9/22)||Monevator (21/1/23)||Median (21/1/23)|
|UK gov bonds||4.3||3.7||4||3.4||3.9|
|Global bonds (£ hedged)||–||–||4||–||4|
|Global aggregate bonds (£ hedged)||4.8||3.6||4.4||–||4.4|
The table shows the ten-year expected returns1 for key asset classes, expressed as nominal average annual returns in GBP.
We have sourced them from a variety of experts.
Monevator’s expected return on equities (including REITs) are calculated using the Gordon Equation.2
The expected return on UK government bonds is simply the prevailing yield-to-maturity of the ten-year gilt.
For average inflation we used the ten-year UK instantaneous implied inflation forward curve (gilts) chart from the Bank of England.
Make sure you subtract your inflation estimate from nominal figures. This gives you a real return figure to deploy.3
Their mileage may vary
As you can see from our table, opinions vary on the expected rate of return.
Methodology, inflation assumptions, and timing all make a difference.
Since our last update, Vanguard and BlackRock have both significantly increased their expected return forecasts. A market fall, ironically, leads to higher expected returns, because earnings and dividend yields improve. You’re paying less for future cashflows.
Incidentally, Research Affiliates and BlackRock provide expected return rates for more sub-asset classes if those above don’t cover your needs. BlackRock’s tool even offers 30-year projections.
Of course, the longer your timeline, the bigger your pinch of salt.
Portfolio expected returns
Okay, so now what?
Well, let’s use the asset class expected return figures above to calculate your portfolio’s expected return.
Your portfolio’s expected return is the weighted average of the expected return of each asset class you hold.
The next table shows you how to calculate the expected return of a portfolio. Just substitute your own asset allocation for the example one below.
|Asset class||Allocation (%)||Real expected return (%)||Weighted expected return (%)|
|Global equities||60||3.45||0.6 x 3.45 = 2.07|
|UK equities||10||4.91||0.1 x 4.71 = 0.49|
|Emerging markets||10||5.28||0.1 x 5.28 = 0.528|
|UK gov bonds||20||-0.13||0.2 x -0.13 = -0.026|
|Portfolio expected return||–||–||3.06|
(For this example I used Monevator’s nominal expected returns minus inflation to derive the real return.)
Feel free to use any set of figures from the first table. Or else mix-and-match expected returns for particular asset classes where you can find a source. Research Affiliates and BlackRock should cover most of your bases.
The expected return of your bond fund is its yield-to-maturity (YTM). Look for it on the fund’s webpage.
Because most sources present nominal expected returns, remember to deduct your inflation estimate to get a real expected return.
You should also subtract investment costs and taxes. Keep them low!
The expected return of a portfolio formula is therefore:
- The nominal expected return of each asset class – minus inflation, costs, and taxes
- % invested per asset class multiplied by real expected return rate
- Add up all those numbers to determine your portfolio’s expected return
The resultant portfolio-level expected return figure can be popped into any investment calculator.
You’ll quickly see how long it’ll take to hit your goals for a given amount of cash invested.
How to use your expected return
Input your expected return calculation as your rate of growth when you plot your own scenarios.
Drop the number into any good investment calculator or in the interest rate field of our compound interest calculator.
As we saw, the expected return rate we came up with in the portfolio above is pretty disappointing.
Historically we’d expect a 60/40 portfolio to deliver a 4% average rate of return.
But after a long bull market for equities and bonds – even given the recent declines – market pundits seem to feel there’s less juice left in the lemon. They’ve therefore curbed their expectations.
If you’re modelling an investing horizon of several decades, however, it’s legitimate to switch to longer-run historical returns.
That’s because we can assume long-term averages are more likely to reassert themselves over 30 or 40 year stretches.
The average annualised rate of return for global equities is around 5% since 1900. That’s a real return. Hence there’s no need to deduct inflation this time.
UK equities weigh in around the same.
Meanwhile gilts have delivered a 1.8% real annualised return.
Even though your returns will rarely be average year-to-year, it’s reasonable to expect (though there’s no guarantee) that your returns will average out over two or three decades. Because that’s what tends to happen over the long term.
Excessively great expectations
In contrast, planning on bagging a real equity return of 8% per year is living in LaLa-land.
Not because it’s impossible. Golden eras for asset class returns do happen. But you’ll need to be lucky to live through one of them if you’re to hit the historically high return numbers.
Nobody’s financial plan should be founded on luck. Luck tends to run out.
Opt for a conservative strategy instead. You’ll be better able to adapt if expectations fall short. And you can always ease off later if you’re way ahead.
Remember your expected return number will be wrong to some degree, but it’s still better than reading tea leaves or believing all your dreams will come true.
Don’t like what you see when you run your numbers? In that case your best options are to:
- Save more
- Save longer
- Lower your financial independence target number
All are much preferable to wishing and hoping.
How accurate are expected returns?
Expected returns shouldn’t be relied upon as a guaranteed glimpse of the future, as if they were racing tips from a kindly time-traveller.
Indeed the first time we posted about expected returns we collated the following forecasts:
These were long-range, real return estimates but the FCA one in particular was calibrated as a 10-15 year projection for UK investors.
What happened? Well, the ten-year annualised real returns were actually:
- Global equities: 7.8%4
- UK government bonds: -2.6%5
- A 60:40 portfolio returned 3.7% annualised.
The expected return forecasts above now look amazingly prescient. They were previously far too pessimistic but the turbulence of 2022 has knocked both equities and bonds down a peg or three.
Previously, 10-year actual returns were far ahead of the forecasts but one explanation is that our returns had been juiced by successive waves of quantitative easing from Central Banks. Perhaps, too, the retrenchment of globalisation is also a factor.
Still, I wouldn’t expect even the greatest expert to be consistently on-target. Rather, it’s better to think of their expected returns as offering one plausible path through a multiverse of potential timelines.
If you can stand it, go back to your investment calculator and dial in a more pessimistic scenario. Then plug in the lowest of all the respected expected return figures you can find.
Look at the pitiful outcome. Wonder if the decimal point got misplaced.
Scoring that nightmare onto your brain might stop you from anchoring on a shinier expected return.
Okay, that was horrible.
Now increase your expectations and peek at a rosier path for a quick morale boost.
Feel better? More motivated? Great!
Now try to forget about the dream scenario, and simply invest for all your worth.
Take it steady,
P.S. This is obvious to old hands, but new investors should note that expected returns do not hint at the fevered gyrations that can grip the markets at any time.
Sad to say, but your wealth won’t smoothly escalate by a pleasant 4% to 5% a year.
Rather, on any given day you have a 50-50 chance of tuning in to see a loss on the equity side of your portfolio.
Every year, there’s on average a 30% chance of a loss in the stock market for the year as a whole.
And on that happy note, I’ll bid you good fortune!
Note: this article has been updated. Some comments below might be past their Best Before dates. Check when they were published and scroll down for the latest input.
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- Note that most corporates badge their expected returns calculations as ‘capital market assumptions.’ [↩]
- Current dividend yield data comes from relevant Vanguard and iShares index trackers. We added on inflation to make our numbers a nominal return. This is purely for comparison purposes with other sources who use nominal returns. Inflation should be subtracted from all nominal expected returns so you’re working with a more realistic real return. [↩]
- Real returns subtract inflation from your investment results. In other words, they’re a more accurate portrayal of your capital growth in relation to purchasing power than standard nominal returns. [↩]
- Source: Vanguard FTSE All World ETF [↩]
- Source: Vanguard UK Gilt ETF [↩]