Why Shares Are Best

Numerous studies have been done about the rates of return that each of the main types of investment have made down the years. The results are reassuringly consistent despite the different organisations that have carried them out and the different countries examined. The one exception is figures for property where there is no real consensus on historic returns as the calculations are extremely complex.

But the one conclusion all the studies agree on is that shares have by far provided the best returns over the years. The rates shown below are from CSFB. They are the annual rates of return since 1918. These figures are adjusted for inflation, also known as the real return. We use real returns to make comparisons simpler. You want to compare like with like, i.e. spending power now versus spending power in the future.

Cash	Bonds	Equities
1.6%	2.3%	7.3%

The numbers may look small but you need to consider the power of compounding. It's a virtuous circle or a snowball effect meaning that even a real rate of 'just' 7% can produce a large sum, given enough time. It also means that apparently small differences can have a significant impact on the final amount. To put this in perspective let's consider what would happen to £10,000 invested over 20 years at the above rates, again in real terms.

Cash	Bonds	Equities
£13,736	£15,758	£40,925

But...

Having said that shares are best we need to qualify that somewhat. The returns from shares are not guaranteed. This is what they have produced in the past and therefore this is our best starting point for estimating what they might return in the future.

The return from shares in any one year varies greatly. On occasions they can do poorly. For example in 1974 they lost 50%. But in 1975 they rose 149%. That type of volatility is exceptional. There have been eleven years since 1918 in which equities have lost 10% or more. That is why you need to invest for the long term, in order to smooth out the bumps.

It is worth pointing out that these performance figures include the Great Depression that followed the 1929 crash, World War II, Black Monday in October 1987, the Asian Crisis of 1998 and the decline in the stock market from the year 2000. Investing in shares over the short term is very risky but the longer you invest for, the less risky and more profitable it becomes.

Watch Out For Charges

At this point we should also mention charges. All else being equal, the lower the charges you pay the higher you can expect your eventual return to be. As we saw in the table above even small percentage differences can make a huge difference to the final amount. Unfortunately, here in the UK we have a financial services industry that has a talent for both high charges and hiding the fact of how high they are.

It also loves to put several layers of middlemen in between your money and its eventual investment destination. Each takes their cut leaving less for you. So read the small print as all investment products have to lay out their charges in what is known as a Key Features document. The industry is moving towards a clearer and fairer charging structure but we've got a long way to go.