Crystal ball time - interest rates

bowlhead99

Mr.Saver said:

Personally I'm a risk taker. I'd construct the problem this way:
My assumptions are:
* Global developed world equities can lose up to 20% of their value in 3 years
* Global developed world equities has a median compound annual growth rate (CAGR) of 6.5% in 3 years
Reason: those are pessimistic estimations based on the past performance of global developed world equities in the last 50 years. In all rolling 3 years period over the last 50 years, global developed world equities GBP inflation adjusted returns have never been down by more than 17%, and the GBP inflation adjusted median CAGR is 6.9%.

While your analysis probably deserves an A+ for effort, the assumptions you describe as 'pessimistic' are, (perhaps due to your nature as a risk taker) too optimistic to be considered pessimistic.  

If you take 1 June 2007 to 1 June 2010 as an example, the FTSE All World Index dropped 32%. 

Granted, that doesn't include dividends, but dividends paid in the period were not high as a fraction of the opening balance, and I haven't adjusted the return down for inflation so it's not outrageously misrepresenting the return. Also, it's all world rather than developed world, but although emerging markets had a few percent deeper drawdown they bounced back faster, and are only a small portion of the all world index, thus not massively affecting the overall returns over that period of v-shaped market movement.

The main reason the ~30% figure is different from your ~17% figure is that the All World index is measured in USD, and during the global financial crisis the dollar strengthened, meaning a significantly worse fall when measured in dollars (peak to trough total return drop of 58% for the index between autumn 2007 and march 2009, while for GBP it was closer to 40)

Around 90-95% of the global equities by marketcap are listed on markets outside the UK and those companies have their assets and revenues substantially in non-sterling. So, if sterling depreciates (as in 2016) a world index is suddenly worth a lot more sterling while if it appreciates you would get the opposite effect. What happened to dollar investors in a world index in 2007-9 was that when dollars strengthened at the same time as the equity markets fell, they lost a lot more value on the half of the global equities that weren't US-listed.

At that time, we fared better because our currency weakened against the USD, so people from the UK think that the global financial crisis / credit crunch era was just a 30-40% blip that fixed itself in a few years. But that is not to say the currencies would always play nicely and insulate us from the world events  - next time, it could be GBP that strengthens, adding a 20-30% currency swing to the underlying terrible market performance. 

Mr.Saver said:

Thrugelmir said:
Did you factor in exchange rates. 

Did you factor in exchange rates? Yes, the returns have taken GBP exchange rate and GBP inflation into consideration.

The observation is that you didn't factor in what could happen to exchange rates, you factored in the GBP historic returns where we were insulated from a very large slump in equities in dollar terms by the fact that GBP fortuitously weakened at the same time. If it didn't, or if it moved the opposite direction and strengthened, that could give a significantly worse outcome.

You may think it far fetched that GBP would strengthen if some disaster hits the rest of the world. But generally I think of world  equity indexes as things that can fall 50% and won't always recover within a year or two or three.  The idea that GBP indexes have never been down more than 17% over rolling three year periods and so 20% is likely worst-case scenario for a UK investor, is really undercooking the potential volatility IMHO, and comes from your 'risk taking' character, as people who like risks are generally optimists about what they can get from the market (which is why they are happy to take the risks).

That said, we have of course already had a drop over the last 3 months so would be unlucky to get another 20-30% to come over the next rolling 3 years.

RG2015 said:

kinger101 said:

RG2015 said:

Algebra, geometry and arithmetic were not separated out and things like sets x,y graphs, vectors and binary numbers were added in. It drove my Dad mad "I don't know what it is but it's not Mathematics!"

There are 10 types of people.  Those that understand binary and those that don't.

The meaning of life. 101010

Common mistake to conflate Monty Python's "Meaning of Life" with Douglas Adams's answer to "ultimate question of life, the universe, and everything"

RG2015

bowlhead99 said:

RG2015 said:

kinger101 said:

RG2015 said:

Algebra, geometry and arithmetic were not separated out and things like sets x,y graphs, vectors and binary numbers were added in. It drove my Dad mad "I don't know what it is but it's not Mathematics!"

There are 10 types of people.  Those that understand binary and those that don't.

The meaning of life. 101010

Common mistake to conflate Monty Python's "Meaning of Life" with Douglas Adams's answer to "ultimate question of life, the universe, and everything"

Why use 8 words when 3 will suffice?

colsten

RG2015 said

Why use 8 words when 3 will suffice?

42

RG2015

colsten said:

RG2015 said

Why use 8 words when 3 will suffice?

42

Touché,  but 101010 is required in response to @kinger101.

Silverbird65

Anyone experience with atom bank? That have 1yr fix 1.4%. not sure about them .
Cheers

kinger101

Mr.Saver said:

I'd argue that any estimation based on a 50 year window isn't that pessimistic.
In the last 50 years the world have seen bubbles and major crashes. The 50 years time contains many economic cycles. Using a longer time frame may not help improving the estimation, because the financial world 100 years ago is a lot different than today's. Even it does have some effects on the estimated numbers, it won't change the big direction. Equities over 3 years don't lose half of their value, and they outperform savings accounts most of the time.

The last 50 years has been a better period that the 50 years before that.  So using the more recent period is cherry picking.  I do not think one can reasonably assume the next three years will be more like three picked between 1970 and 2020 than 1920 and 1970.  Some might say the earlier period might be more relevant given current events. But both of us here are GUESSING.

It's also not clear whether OP needs £60K absolute or £60K relative to today's values.
If the OP needs today's 60k in 3 years, choosing a 1.55% interest rate savings account is unlikely to help either. Because the inflation in the last 10 years (2009-2019) averaged at about 3.1% per annual. (Source: https://www.bankofengland.co.uk/monetary-policy/inflation/inflation-calculator) In fact, by investing a part of the money in equities, the portfolio has a better chance to loss less buying power over time.

March 2020's annual CPI figure was 1.5%, so a 1.55 % interest rate is going to match inflation.  I think a reasonable estimate based on the last decade is that interest rates might be 0.5-1.0 % below CPI.  So in three years, at -1 %, OP might have £58,218 instead of £60,0000.  While equities has a better chance of beating inflation, it has a better chance of not doing so.  By a spectacular amount. 

Your argument seems to be OP can afford to lose a little of it, which might be the case.
I didn't argue that the OP can afford to lose a little in the first post. In fact I've taken the market downturn into consideration and in the historically worst case scenario the OP would still have 60k at the end of 3 years. It was to answer your question that the estimation of 20% downturn may not be enough, I said that OP can afford to lose a little if the future turns out to be much much worse than the history.

If you're agreeing they might be a downturn, then by default, you're accepting they can afford to lose some of the money.  Your scenario ignores inflation.  And history isn't the same as the future.

But you can't assess capacity for risk without knowing what OP is buying in 3 years, and how currency movements and inflation might impact its future price.
What OP is buying in 3 years is irrelevant here, be it a deposit for a house in the UK or a fancy sport car imported from the EU, it has been budged for 60k in GBP. The budget should consider the currency movements, inflation and the future price, not the portfolio.

Sentence two seems contradictory to sentence one.  But currency risk and inflation risk are never irrelevant. Hedging against currency risk would be sensible if it's sports car manufactured in Italy.  

To summarize, there's no point pretending equities are a suitable home for short-term investments where one's aim is preservation of capital.  While savings accounts are likely to under-perform inflation, it's by a small and relatively predictable amount.  Anything in equities is a bit of a punt over that short a time.

colsten

Silverbird65 said:

Anyone experience with atom bank? That have 1yr fix 1.4%. not sure about them .
Cheers

They should be ok if there is FSCS protection. You can get 1.45% though at Ford Money or BLME, and 1.5% at Gatehouse. https://moneyfacts.co.uk/savings-accounts/1-year-fixed-rate-bonds/

Ronder33

If the UK government keep creating imaginary money to avoid economic reality then sooner or later inflation will spike.
USA and Europe following similar path of imaginary money creation.
In my opinion I would invest the £60k into £20k gold, £20k silver, £10k bitcoin and £10k in Yuan.
Sterling is not to be trusted until the government begin to run a budget surplus and start paying back the borrowed billions. 

2unlimited91

Ronder33 said:

If the UK government keep creating imaginary money to avoid economic reality then sooner or later inflation will spike.
USA and Europe following similar path of imaginary money creation.

All money is based on trust: on being part of a society, in which certain tokens have a generally recognized value. Seen in that light, there is nothing "imaginary" about the currencies of the UK and the USA. They are currencies which have a value because the UK and USA are functional societies (notwithstanding that they are in some ways dysfunctional), and their currencies are deeply embedded in how those societies operate.

Ronder33

2unlimited91 said:

Ronder33 said:

If the UK government keep creating imaginary money to avoid economic reality then sooner or later inflation will spike.
USA and Europe following similar path of imaginary money creation.

All money is based on trust: on being part of a society, in which certain tokens have a generally recognized value. Seen in that light, there is nothing "imaginary" about the currencies of the UK and the USA. They are currencies which have a value because the UK and USA are functional societies (notwithstanding that they are in some ways dysfunctional), and their currencies are deeply embedded in how those societies operate.

Yes although your missing a basic economic supply and demand fact.

if you create more pounds , euros or dollars out of thin air the value of existing pounds, euros and dollars will decrease.