GLOBAL - The Organisation for Economic Cooperation and Development has published fresh evidence suggesting long-term investment returns will have to be revised downwards, as equally weighted portfolios can hit 9% returns in just 10% of cases.
A research paper has been released entitled Investment Risk and Pensions: Measuring Uncertainty in Returns (Employment, Social and Migration Working Paper No. 70) which contains complicated mathematical analysis of investment risk and historical returns generated by pension plans in eight OECD countries - Canada, France, Germany, Italy, Japan, Sweden, the United Kingdom and the United States.
This paper reveals plans in the past delivered a median real return of 7.3% a year on a portfolio of equally-weighted equities and bonds, but the swing between returns can be so vast that the OECD is suggesting predicted returns should be lowered.
More specifically, it found the degree of uncertainty in returns means that in 10% of past cases the annual return is less than 5.5% while in 10% of cases it is 9%, yet if investors were to settle on a 5% annual return - net of charges - the actual return, on a regular 10% contribution, would for 80% of the time be between 3.2% and 6.7% a year.
Officials noted the wide swing could amount to enormous sums of money over a 40-year investment period - especially as average investments in most countries are less than 10% because of administration charges, governance, regulatory effects, and demographic changes, so more conservative assumptions should perhaps be adopted.
Interestingly, it also noted that many of the baby-boomers who have been buying investments in recent years will begin to sell them in the future, so further warned returns must expect to be lower.
“Some commentators have argued that the accumulation of retirement savings…has driven up financial returns over the past two decades. As the baby-boomers begin to retire in a decade’s time, its members will sell at least some of the financial assets that they accumulated when working.
“The younger generations are also much smaller in size an so many have less demand for financial assets. Also, there will be an increase in the amount of physical capital per worker. Both of these mechanisms will tend to drive down rates of return and the value of financial assets. The most alarmist interpretation of this possibility is the “asset-meltdown hypothesis,” the report’s authors continued.
“A range of studies, using different modelling strategies, concur that shocks to the rate of population growth are likely to affect equilibrium asset returns. However, the fall in the rate of return as the population ages is far less than would merit the sobriquet of a “meltdown in asset prices”. Nonetheless, it seems reasonable for projecting the future to make a conservative assumption that the return on assets over the past quarter century may not be repeated.
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