What is a realistic return for a 5 yr investment ?

Happychappy

Hi

I may soon have a relative returning from abroad who has sold a property, realising around 500k

He will not need to use this money for property in the uk, as he has a small property he rented out, but will be moving back into, he will not be relying on it for essentials, he currently has a pension which he can live on fairly comfortably, however, would like to put his capital to good use to try and increase the amount of capital, so that in five years he can reassess his options?

In essence, what what be a realistic annual return on his capital, he is not a great risk taker, but realises investment is a risk, however, he would except a low to medium risk, which in his understanding would be losses around 10% ?

I know there is no easy answer, but from years of experience, what would be a conservative % return he could expect, and would this be achieved! bonds! equities ?

He will be a 20% tax payer when he returns! His pension is between 20 - 24k gross, he has his property in the Uk, car etc, so no great outlays, which is why his pension should about cover everything, he also has around 50k nett in building societies for a rainy day account, I.e years of cash ISA's

Obviously subject to any returns he makes, this may put him into a higher band, but looking at the returns of safe savings on offer in the region of 2% gross, the building society route is not favourable! he has not used his S&S ISA allowance

Thanks HC

masonic

With only a 5 year horizon, that would rule out having the majority in equities. Probably 20-40% equities and the remainder in bonds would get the risk balance about right, with a return after inflation of about 3%. £500k is a pretty large portfolio to suddenly take on - does he intend to DIY or seek advice?

Totton

Why not take a look at few Investment Trusts and determine which would be akin to your friends attitude to risk. Then take a look at the 5yr performance of such a holding. That should give you an idea of what to expect if markets trundled along in the way that they have of late - but will they?

I'm not suggesting that the following are bought, merely that may give an indication to 5yr performance.

For a low to medium attitude to risk then you probably need to look at the performance of more boring type IT's such as Personal Assets (+60.5%), Ruffer (+50.6%), RIT Capital Partners (+49.2%). There are of course many others.

If you use the AIC tables or Trustnet you can look at this information quite easily http://www.trustnet.com/Investments/Perf.aspx?univ=T&Pf_sortedColumn=RiskScore.Score&Pf_sortedDirection=Asc

Personally I would caution against expecting these kind of 5yr returns in the future but who knows what will happen in that time.

Happychappy

masonic wrote: »

With only a 5 year horizon, that would rule out having the majority in equities. Probably 20-40% equities and the remainder in bonds would get the risk balance about right, with a return after inflation of about 3%. £500k is a pretty large portfolio to suddenly take on - does he intend to DIY or seek advice?

He would seek advice ?

Happychappy

Totton wrote: »

Why not take a look at few Investment Trusts and determine which would be akin to your friends attitude to risk. Then take a look at the 5yr performance of such a holding. That should give you an idea of what to expect if markets trundled along in the way that they have of late - but will they?

I'm not suggesting that the following are bought, merely that may give an indication to 5yr performance.

For a low to medium attitude to risk then you probably need to look at the performance of more boring type IT's such as Personal Assets (+60.5%), Ruffer (+50.6%), RIT Capital Partners (+49.2%). There are of course many others.

If you use the AIC tables or Trustnet you can look at this information quite easily http://www.trustnet.com/Investments/Perf.aspx?univ=T&Pf_sortedColumn=RiskScore.Score&Pf_sortedDirection=Asc

Personally I would caution against expecting these kind of 5yr returns in the future but who knows what will happen in that time.

I believe a return of 5/6 % per annum is more what he is hoping for but without a high risk ?

innovate

Happychappy wrote: »

I believe a return of 5/6 % per annum is more what he is hoping for but without a high risk ?

Wouldn't we all.

dunstonh

50,000 odd investments available across the risk spectrum. You need to narrow down more

he would except a low to medium risk, which in his understanding would be losses around 10% ?

10% loss potential is more very very cautious.

innovate

dunstonh wrote: »

10% loss potential is more very very cautious.

Even for a pensioner whose age, and plans for his money, we do not know?

He could already have ordered his Lamborghini and might need the money in 6 or so years time.

robatwork

£450,000 spread around banks and savings accounts.

£50,000 on black/red on the roulette table.

That's risk of 10% loss or 10%+ gain.

masonic

Totton wrote: »

For a low to medium attitude to risk then you probably need to look at the performance of more boring type IT's such as Personal Assets (+60.5%), Ruffer (+50.6%), RIT Capital Partners (+49.2%). There are of course many others.

I must admit I was lazy and only looked at the first one, but that one fell over 30% from mid-2007 to late-2008, so that would be a bit above the 10% loss potential suggested and could result in some unhealthy panic selling if there was a future market crash.

bowlhead99

dunstonh wrote: »

Happychappy wrote: »

In essence, what what be a realistic annual return on his capital, he is not a great risk taker, but realises investment is a risk, however, he would except a low to medium risk, which in his understanding would be losses around 10% ?

10% loss potential is more very very cautious.

innovate wrote: »

Even for a pensioner whose age, and plans for his money, we do not know?

He could already have ordered his Lamborghini and might need the money in 6 or so years time.

What Dunstonh is saying that regardless of plans for his money in the 5 or 6 years time - whether he has the Lambo on order and whether he plans to live for 40 years or 5.5 years - if he's only looking to lose maximum 10% in a five year period he is not looking for 'low to medium risk'. He is looking at something a bit more risky than zero-risk cash, but not much more, nowhere near 'medium risk'.

A zero risk insured investment like cash, he will be lucky to get inflation plus zero, or an absolute rate of two to three percent if he goes for a long fix and sacrifices the chance to change his account part way through to find a higher market rate as rates and inflation go up over time. So after splitting the 500k between various banks this might get him say 12.5% total return after it compounds up.

However, what he wants is

I believe a return of 5/6 % per annum is more what he is hoping for but without a high risk ?

and he was hoping that would be the answer from us to his question above:

... from years of experience, what would be a conservative % return he could expect?

If we compound up his 5.5% per annum for five years, we get 31%.

So, what investment will go up by 30%+, (conservatively, i.e. hopefully will really go up by say 35-40%)- without risk that it could go down by as much as 11% in the relatively short timescale of 5 years? If there's one out there I'd like to know it myself.

Sure, based on long term historic averages, a balanced portfolio of stocks and bonds can go up by 5.5% per annum when left for long enough - maybe more. But they can also go down and the re-evaluation point in 5 years time does not give them time to recover back up to £450k+ if that's the minimum acceptable target.

An equity-heavy fund is too high up the risk scale. A bond heavy fund does not give even two thirds of the return he wants unless it is a riskier one which also has the capacity to drop 15-20%+. At the moment 5-year gilts are yielding 1.9% and 10-year gilts are yielding 2.6. So, safe, short dated gilt funds which are nice and low on the risk scale are not paying as much as he wants and if their rates go up their capital goes down. If you look abroad you can get 5% if you invest in Greek government bonds, but you have higher default risk plus FX risk. You can easily lose 10%, so that's out.

It is a similar story with investment-grade corporate bonds. Rates lower than his target with risk to capital. I mean, yes there are higher yield bonds out there, the riskier the company the more they pay. It's easy to find individual individual retail bonds or preference shares with a higher yield than 6% - how about Co-op group or Lloyds or Nat West? Of course if you buy 10 of them with your 500k and base interest rates go up a couple of percent causing their capital to fall, and maybe one or more of the companies go bust you can easily lose more than 10% over the 5 years. You could try to minimise picking bad ones by paying a fund manager but then it's costing you yield and you're still not protected from interest rate rises.

I know there is no easy answer, but

There isn't an easy answer if you have to deliver 30% while allowing a max loss of 10%. Effectively you are looking for something which sacrifices the potential returns above 5% p.a. to buy insurance against losses. There are some 'structured products' around but often not great value: do not usually give full protection in a big crash or bankruptcy of the counterparty; might preserve your capital but not give you any return at all if markets do poorly (in which case cash would have been better for its guaranteed, albeit low, return).

The key bit is (my emphasis bolded below):

would like to put his capital to good use to try and increase the amount of capital...

If he's only trying to increase it and will accept failure to make anything at all (i.e. "oh well, at least I tried, I haven't lost too much") then there are some lower risk fund or structured products he could try, or the robatwork approach above.

Certainly if he holds back 450k as cash and makes 45-50k of bank interest on it over the years, he can treat the other 50k starting cash as a high risk gambling/investment pot with a chance to triple it or bust. If he makes 100k profit from that investment venture, he has a best case scenario of walking away with 500k start cash plus 50k bank interest plus 100k investment profit = 650k total. That's 30% more than what he has today and meets the 5-6% annualised return objective. Unfortunately there's only a 1 in 3 chance of it happening and two thirds of the time he would just have 500k in the bank and zero returns.

But hoarding cash and letting a bit out to gamble is an example of giving up potential returns to preserve capital. For a one third chance of tripling your money instead of losing it, consider playing roulette - bet on it landing on numbers 1 through 12 on the 37-spot board. Or betting on a yes vote for scotland independence at your local bookies. Or maybe piling into bitcoins and hoping they treble instead of crash. There are plenty of other options out there.

Bottom line, 6% average compound return pa with no risk of it falling to below 90% of its starting value, does not exist. With many 'market' based investments from shares to property to bonds, you can get access to a potential 30%+ over 5 years if you're willing to risk losing the 30% over five years. It sounds like he would be unwilling to play in that pool. If he would accept a more realistic 3-4%, there is probably something out there for him that gets returns better than cash but not as high the 5-6% he will hear about other people making (or losing) over the same timeframe.

so that in five years he can reassess his options?

Obviously we don't know much about this relative - it sounds like he is financially OK with a house and car and as much income as he needs. So this 500k might be either to give him an income boost for the few years he can enjoy it, or a smaller income boost for longer, or perhaps no meaningful income but optimum tax-protected growth to maximise the total inheritance for his heirs. One point worth raising is, why the desire to preserve capital to reassess in 5 years? Why not properly assess now?

What can happen with some people is they will put off the decision until a few years down the road, hoarding cash in a low interest vehicle for fear it might be lost before the point they decide what to do with it. After some years they reassess and just do the same and kick the can down the road.

Then after 3 years they realise that shares and properties have trebled so there is no point buying now at high prices, they stay in cash. After the next 3 they see that shares have halved and there's been a property crash so that scares them away from investing in case that happens to them. So they stay in cash and the market goes up without them again.

Rinse and repeat this practice every 3-5 years for 6-10 times, and you have kicked the can down the road for 30 years. Like pressing snooze 10x in the morning instead of getting an hour of sleep, it's not very efficient. Because inevitably, short term solutions restrict the gains you can have by thinking long term.

Hope this is food for thought though I appreciate it doesn't actually give you an investment program. You mention that he would seek advice. So, by going through his needs and goals, a professional should be able to sort him out. It might cost a couple of percent to get some tailored guidance and support - but as you mentioned, he's trying to avoid bank or building society accounts because a return of 2% here or there makes no meaningful difference to his lifestyle. So it could well be the best non-meaningful chunk of change he ever spends.