What you can learn from past performance
Summer 2006 Financial Bulletin
‘What return will I get from my investment?’
It sounds a simple enough question and it is one financial advisers are asked every day. Unfortunately there is no real answer. For example, if you put cash in a typical deposit account, the interest rate could change at any time. Even if you choose a fixed rate, fixed term deposit, your overall return is still not completely certain. Tax levels could alter and so could inflation, both of which would affect the buying power of your investment when it reached its maturity date.
There are greater uncertainties outside the world of deposits. The value of investments in shares or bonds can fluctuate – as has happened over the last six years – and you might not get back a significant proportion of your investment. However, you should not place any great reliance on what has happened since the turn of this century: as the investment advertisements regularly remind us, past performance is not an indication of future performance and may not be repeated.
In spite of the unreliability of the past performance crystal ball, investment experts still spend a considerable amount of time and computing resource on looking at what has gone before. The classic example of such research is the Barclays Capital Equity Gilt Study, which in one form or another has been published annually since 1956. The 2006 Equity Gilt Study provides a mine of information on the annual returns of UK shares, government bonds (gilts) and sterling deposits from the beginning of the 20th century.
The study’s long term results paint an interesting picture. Over the last 10, 20 and 30 years to the end of 2005, UK shares have outpaced cash deposits based on pre-tax returns. However, in the last ten years, government bonds beat UK equities, as did 15-year corporate bonds. Not surprisingly, over the five years from December 31 2000, UK shares were the worst performer.
Although the weight of past statistics cannot tell you what next year’s results will look like, they do give a historical justification for one important principle: the diversification of investments. As the data show, there has been no one category that turns up trumps every year. The investor who chose a long term mix of cash, bonds and equities will generally have had a smoother ride than the pure equity investor and usually have beaten the returns from holding only cash.
