Doubling your wealth in 10 years wasn't a particularly challenging target back in the 1980s and 1990s. The go-go years of globalised labour, privatisation, plus weakening inflation and interest rates provided equities with an enduring boost. According to the Barclays Equity Gilt Study, that produced an average real return, income reinvested, of 12.9 per cent a year from 1980 to 1999 inclusive, enough to double your real wealth in five and a half years. Yet from 2000 to 2011, the average annual return has been minus 0.2 per cent, not enough to even keep purchasing power of an invested sum constant.
Clearly, the gloom felt by investors today is in the dramatic deceleration in market returns from a period of abnormally high returns, to a period that marks the worst since the Great Depression of the 1930s. History shows that such good and bad periods - days, months or years - are often juxtaposed.
Yet even in the austere and income-constrained investment climate of 2012 it is realistically achievable to double a sum in 10 years in nominal terms. It requires only 7.2 per cent return a year (see 'The rule of 72' below) which equates to the long term average return of the UK stock markets over the longest periods (five per cent real return, plus average inflation of about 2.5 per cent). The aim is to put together a strategy which requires the minimum day-to-day oversight, relying largely on substantial and growing income sources to provide the main engine of returns, perhaps five to six points of the 7.2, and with just a whisker of price appreciation assumed to reach the target return. The idea is that the strategy will hit the target even if current miserable conditions persist, but of course if they improve at all, which history suggests is now likely, then returns will be better still.
Starting point: costs
The logical starting point of any such strategy is a more fundamental stance: the minimisation of overheads. Gaining 1 per cent a year on returns may entail extra risk, and may not always be successful. But a laser-like focus on overheads, fixed account costs, management fees and behavioural costs such as over-trading, reaps more reliable rewards. Just 1 per cent saved this way drops to the bottom line, each and every year.
The disparity between the best and worst value trading accounts, Isas, Sipps and other investment vehicles is many hundreds or sometimes thousands of pounds a year (see our survey of stockbrokers). Failure to harvest obvious tax benefits is costly. The use of tax wrappers such as Sipps can add as much as two thirds to the value of investable funds for higher-rate taxpayers. When I undertake individual investment reviews, I notice time and again that investors who are happy with the risk of holding individual stocks such as Vodafone or AstraZeneca also hold managed funds that boast the very same FTSE 100 stocks but charge 1.5 or even 2.5 per cent a year for the privilege.
Second tier: Income
Almost every piece of academic research on investment returns shows that the reliability, continuity and reinvestment of income is the keystone of long-term investing success. Unlike trading - which constantly seeks out market mispricing - the pursuit of income is built for low-maintenance investing. The table below represents a typical return from reinvested income across a variety of assets, and starting from 1990 covers times when price returns were variously good and bad for all the assets concerned. If the implied returns of owner-occupied housing could be included too (in the form of rents saved and reinvested, plus price movements), they would further support the view that many investments, when - crucially - held with minimal overheads would easily allow a doubling of wealth in a typical decade, and a quadrupling in two.
£100 invested at end 1990, at end 2011 with gross income reinvested
| Nominal | Real | |
|---|---|---|
| Equities | £498 | £297 |
| Gilts | £500 | £298 |
| Index-linked gilts | £369 | £220 |
| Corporate Bonds | £628 | £374 |
| Source: Barclays Capital | ||
Asset allocation
Of course, if you are going to buy and hold, the importance of picking the right asset becomes even more central. Holding a poor investment for a decade is clearly going to dent returns more than one held typically for a year. Once again, income often holds the key. Getting a high initial yield is important. High income isn't only good for its own sake, but is often an indicator that an asset is out of favour, misunderstood and due a rebound. Conversely, historically low income and high prices often mean that an asset is riding for a fall.
It would be wonderful to be able to use rock-solid government debt or the very highest rated company debt as the cornerstone of this strategy. If 10 year gilts yielded 5 per cent instead of 1.3 per cent, that would be easier. But with average corporate debt offering only 173 basis points more than the equivalent duration US Treasuries, and AAA rated corporate issues yielding 2.62 per cent, these safe havens place too much reliance on assumptions about price to reach our 7.2 point target. If you are getting, say, 3 per cent income from bonds, assuming a 4.2 point boost from annual price appreciation is just too much. Still, there are three types of security, two fixed interest and one from equity, which combined do offer a very good chance of reaching that magic 7.2 per cent a year.
Junk bonds
High income is a signal of perceived high risk, but often those risks are overstated. That has been true of junk bonds, securities issued by companies that credit reference agencies assess as less than investment grade. These bonds are termed junk because the issuers have a significant chance of default. But let's get this into perspective. At the lowest ebb in 1933 the rates of default on junk were 15 per cent, and in the global financial crisis they never climbed above 11 per cent. Even on defaults - which are concentrated on the very lowest quality junk - a third or more of debt is recovered. Junk bonds, and those that are a little less risky but still have high yield, have been stellar performers. They have returned an average of 9.75 per cent a year over the last 10 years, and 10 per cent so far this year. The best way to hold them is through a low-cost fund of which the cheapest are exchange traded funds (ETFs). With most issuers being US corporations, they are well-insulated from any eurozone crisis fallout, too. Our strategy, however, doesn't make any heroic assumptions about further price gains, but looks at the yield. ETFs of high-yield debt, such as SPDR Barclays' JNK, and iShares' HYG, still yield over 7 per cent and have low expense ratios, typically below 0.5 per cent. There are plenty more out there.
Preference shares and Pibs
With most forms of investor income under pressure, the fabulous yields of 6-10 per cent available on UK preference shares and the permanent interest-bearing shares (Pibs) of building societies reflect a market that is thin, fragmented and quite complex. Yet for a buy-and-hold investment, these unfashionable oddities offer very reliable income, and in the last few months some firming prices too. Just two examples suffice to show the stability and reliability of some of these. The preference shares of Ecclesiastical Insurance, which principally makes its money from insuring the buildings of the Church of England, pay a net yield of 7.31 and it is as solid as the institution into which it is tied. The 13 per cent coupon subordinated bonds of the mutually-owned supermarket and funeral group Co-Operative offer an 8.39 per cent gross yield, and this one is a perpetual too.
Dividend-bearing shares
The dividends of ordinary shares are by no means as reliable as those paid by bonds, even junk bonds. Those who plump for the fattest indicated yields are often doomed to disappointment as many of these are unsustainable. The share price slides that produce those eye-catching yields are often telling us just that. More reliable, for those who want to reach their 7.2 per cent each year, are the sizeable but growing payouts made by companies with a demonstrable leadership in their field and a long track record. Better a 4 per cent payout growing by 5-10 per cent a year than one of 8 per cent, barely covered by earnings, in a struggling company. There are dozens of good dividend candidates with track records of 10-20 years of such dividend growth, but four suffice. Scottish & Southern Energy, with a current yield of 6 per cent, and which has increased payouts by an average 12 per cent since 1998, pharmaceutical giant GlaxoSmithKline (yield 5.2 per cent, average 6 per cent since 1987), cigarette company BAT (3.8 per cent and 11 per cent since 1998) and Domino's Pizza UK (2.5 per cent yield and a staggering 57 per cent average increase since 2001).
Now there are all sorts of trade-offs to be made here between the size of yield and its growth, and these are perhaps best expressed in a chart (see below).
Dividend yield growth
The payout from a 2 per cent yield (yellow) climbing at 20 per cent a year, eventually overtakes both a 4 per cent yield (blue) climbing at 10 per cent and a 6 per cent (red) climbing at 5 per cent, but for total income over 10 years (and even more for reinvested income) an investor does better with the higher initial yield with slower growth. But this is only half the story. Companies with consistent fast-growing dividends also reap price gains which may dwarf the income itself.
