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Viewing the future through a range of possibilities

08 March 2017 | Todd Schlanger

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Growing up in the United States, I never envisioned living outside the country. Nevertheless, I studied abroad in Australia and recent years have seen me working in Vanguard's offices in London, before most recently moving to Canada. With the benefit of hindsight, I know these moves are some of the best decisions I've made.

Having grown up as a southerly neighbour, I find some things about Canada feel familiar. Others are more uniquely Canadian: poutine (a Québécois delicacy made with french fries and cheese curd), Hudson's Bay department store, the country's affection for the rock band Tragically Hip, and Hockey Night in Canada, a national institution broadcast on the CBC.

I mention the winding road my career travels have taken because as investors we often seek precision regarding the future. We want to know how our portfolios are going to perform, and the reason is obvious – it would help us plan ahead!

Forecasting the future

However, it's the uncertainty regarding the markets for which we are compensated in the long run as investors.

It's with this in mind I recommend reading Vanguard's annual market and economic outlook. Our research spans the global macroeconomic environment, inflation, monetary policies, interest rates, equity and fixed income markets, as well as asset allocation considerations.

We use our proprietary Vanguard Capital Markets Model® to forecast distributions for ranges of potential outcomes. We believe the advantage in doing it this way is that we show a central tendency for the more likely outcomes, but also quantify the full range of outcomes investors may experience through a probabilistic approach.

Putting our outlook into perspective

One thing is clear from our outlook: The range of returns will likely be lower over the next ten years than we've experienced since the end of the Global Financial Crisis.

Our simulations suggest the central tendency for global fixed interest returns over the next decade will be in the 0%–2% range and the 5%–8% range for global equities. The return of a balanced portfolio of 60% equities and 40% bonds is expected to centre in the 2%–4% range, below the actual average real return of 4.9% for the same portfolio since 1926.

Taking this into account, I'd like to highlight three things investors can do to increase their chances of investment success regardless of what the future holds:

  • Save more for retirement by increasing their savings rates or working a few extra years.
  • Plan on spending less from their portfolios in the drawdown years.
  • Reduce the bite costs take from their investment returns.

The first two options can have the most impact but can be difficult to implement in practice. Reducing costs is an often overlooked option but can also be very effective.

The figure below illustrates this by showing the percentage of return consumed by investment costs at various hypothetical returns. As you move from right to left, it's notable that the percentage of returns going to costs increases exponentially for higher-cost portfolios (represented by the 100 bps and 150 bps lines) while this percentage remains low for the lower-cost portfolios (represented by the 5 bps and 20 bps lines).

Why low costs matter more when returns are low

Percentage of return claimed by costs for various hypothetical returns:

Note: bps=basis points. This hypothetical example is for illustrative purposes only and does not represent any investment. Source: Vanguard.

These small differences in costs compound to big differences in the long run. For example, using the two middle lines in the figure of 20 bps and 100 bps, the difference between investing £10,000 in a portfolio earning a hypothetical real return of 3% over 10 years at the two costs is £1,019 (£13,173 and £12,154 respectively) or about 10% of the initial investment.

I think Albert Einstein said it best: "Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it."

What investors can control

So much about investing is outside our control. Savings, spending and costs are not. Keeping costs low will ensure they remain a low percentage of returns regardless of what the markets deliver over the next ten years.

After all, as I've learned during my travels, it's best to always prepare for the unexpected. I look forward to exploring more of Canada. I've heard British Columbia is quite beautiful – and that I should bring an umbrella!

Important information:

This document is directed at professional investors and should not be distributed to, or relied upon by, retail investors. It is designed for use by, and is directed only at, persons resident in the UK.

This article was produced by The Vanguard Group, Inc. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

The opinions expressed in this article are those of the individual author and may not be representative of The Vanguard Group, Inc.

Issued by Vanguard Asset Management, Ltd, which is authorised and regulated in the UK by the Financial Conduct Authority.

VAM-2017-02-22-4373

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