What kind of returns can I expect on my investments?

This is the million pound question. Unfortunately, it comes with the answer that it’s impossible to know how your money will perform in the future.

Regardless of what you invest in, there’s simply no guarantee you will profit. However, we can look at what has happened in the past and learn some lessons from earlier investors. Just remember that what’s worked in the past may not work in the future.

How global investors have fared in the past 20 years

In the past 20 years, the Investment Association’s (IA) global sector, including funds that invest in companies worldwide, has returned 392% including dividends, or a compound average of 8.25% each year.

In other words, if an investor put £10,000 into a fund that matched this average IA performance, they would have £49,200 before fees after 20 years, making nearly five times their money.

In hindsight, this may sound very appealing. But those investors also would have weathered some tough periods of market returns.

In 2008, they would have watched the value of their investments drop from over £13,000 to less than £8,500 as the markets were battered by the financial crisis. And after building their money up to over £31,000 by 2020, it would have dropped to less than £24,000 amid the pandemic.

Notably, the period in 2008 would be the only time that the value of their money was less than what they originally invested. By 2009, the value would recover and not dip below the original £10,000 value again.

The US versus the UK

The US has been a well-known investment powerhouse for years now. But have investors really been that much better off with assets over the pond versus in their home market?

In the past 20 years, frankly, yes. The IA’s North American sector has returned 638% including dividends over the past two decades, almost tripling the return of the IA’s UK All Companies sector of 232%.

This means a yearly average return of 10.5% for North America, versus 6.2% for the UK.

Interestingly, this hasn’t always been the case. From 2005 to 2015, the North American sector averaged a return of 104%, while the UK sector averaged 85%. And up until mid-2014, the sectors went back and forth on who had stronger returns. Where the differentiation really became prominent was in the years following 2015, where the US took off and the UK was unable to keep pace.

It’s impossible to know if this trend will continue in the future, but it’s helpful to stay aware of the nuance in the numbers. The past decade has been a time of exceptional growth in the US. Some of this can be attributed to an interest rate environment that is lower than it has been historically, making it easy for companies to borrow money and grow.

In the past decade, the US has had an average interest rate of just above 2%, while the 50-year average is 4.7%. Usually, interest rates opt for the extreme rather than this middle of the road, which can be a factor in why markets can be so volatile.

Recently, the stock market has snapped back from any downturns quickly. But it’s important to know that this isn’t always the case. In 1973, the US stock market as measured by the S&P 500 index entered a slump where the value fell by near 50% over the course of about two years. It took until 1980, seven years later, for the market to recover to its original price.

Opting for bonds

As of 3 September, the 10-year gilt is averaging a yield of 4.8%. This means that if you bought a gilt for £100, the amount you'd be paid for holding the bond each year would be £4.80. This is a higher yield than gilts have offered over the past decade, which has been around 2%.

You can also sometimes buy corporate bonds, which often have higher yields, but these are harder for retail investors to access. Often, retail investors opt for corporate bond funds instead. Investment-grade corporate bonds have a yielded in the region of 4% over the past decade, while high-yield bonds have yielded closer to 6%. However, with all of these come with their own set of risks and typically, the risk goes up as the yield goes up.

Cautious investors may be more comfortable putting their money in bonds because typically, there is less volatility and risk around the assets. The downside is that bonds typically produce a lower return than equities.

When looking at bonds, it’s first important to determine if you plan to buy a bond directly, or if you plan to invest in a bond fund.

If you buy a bond, you might just opt to hold it until maturity and take the interest rate payments. In this case, unless the bond defaults, you’ll know exactly what you’re getting.

If you invest in a bond fund, there may be more variation because the bonds aren’t being held to maturity; they are being bought and sold so the value fluctuates depending on the market.

In the past 20 years, the IA’s Global Corporate Bond sector has returned 150%, while the IA’s UK Gilt sector has returned 52%. This may seem measly compared to the returns that equity funds were making, but fixed income investors didn’t have to weather as extreme of drops in the market of their equity counterparts.

This is why bonds are often a popular option for investors who are nearing a time where they plan to spend, such as retirement or a house purchase.

Historically, the gains haven’t been as large, but the stability means that you can have a clearer picture of how much money you’ll have when you need to use it. But remember, these investments still aren’t immune from volatility. There can still be drops and rises in the market, they just tend to be less extreme.

An example in practice

For instance, let’s say you had some unfortunate timing and planned to retire in 2009, right after the financial crisis. From August 2007 to August 2009, the IA Gilts and Global Corporate Bond sectors had positive returns, gaining 19% and 16%, respectively. But the IA Global Equity sector was down almost 12% in this two-year period.

If you were able to stay invested throughout this time, it would turn out to be a short-term problem, as equity investments recovered relatively quickly.

But, if you were planning on drawing this money, you’d suddenly be met with a smaller pot than you may have anticipated. That’s when fixed income can be a compelling choice, for investors that don’t have time to weather the storm.

Even when it comes to bonds, stability isn’t a guarantee. If you purchase a bond at face value and hold it until maturity while it paid out interest and paid you back the original value of the bond at the end, you will know exactly the amount coming into your pocket over that period. However, there is the risk the bond issuer could default on repayments, and you don’t get paid back in full.

Bond funds will have a range of different investments maturing at different times. Once the bonds mature, the proceeds are recycled into other bonds. The aim is to provide a smooth stream of income to investors and the potential for some capital growth if the bonds are bought at a good price and subsequently go up in value.

It isn’t always a smooth ride as bond prices can move up and down during their lifespan, meaning there is the risk you lose money at points in the journey.

What if you kept your money in cash?

You can typically get an idea of what kind of savings rate you can expect on your cash based on the current Bank of England interest rate (known as the ‘base rate’). Currently, this is 4% after cuts earlier this year. But there will still be variation on the amount of interest you will gain on your cash savings depending on what kind of savings account you hold, and if you shop around for the best deal.

Tools like the AJ Bell Cash savings hub can help you shop around for better rates as interest rates move up and down.

It may seem like keeping your money in cash is the best way to eliminate risk. While the value of that money won’t fall beyond what you’ve saved – unlike investments which can decline in value – there is an underappreciate risk associated with cash savings.

Inflation can eat away at the buying power of cash quickly. In the past decade, inflation rose near 32%, while money held in cash with the same interest rate as the Bank of England base rate would have grown just 16.6%. So even though you aren’t losing any money, it won't go as far when you spend it.