How we forecast potential investment returns

Brad Holland


4 min read

If you’re creating an investment portfolio or looking to invest in a fund, the chances are the first thing you want to know is what kind of returns you’re likely to get. Here’s how we forecast potential returns at Nutmeg.

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Forecasting investment returns isn’t as simple as projecting a single number, and returns can’t be guaranteed, of course. But understanding the likelihood of each possible outcome and how it has been calculated by your investment manager can really help inform your decision-making – in particular, the level of risk you’re willing to take and how long you want to invest for.

At Nutmeg, we’ve designed a suite of free interactive portfolio tools to help inform your investment decisions.

You can create a sample portfolio in just a few minutes by selecting your investment goal and timeframe, how much you’d like to invest, a risk level from one to ten, and how you’d like us to manage your money.

We’ll then show you the kind of portfolio we could build for you based on the information entered, and a series of possible projected returns.

How we calculate projected returns

The investment projections we show are never a guaranteed predictor of future performance. They’re there to give you context and help you make decisions about the kind of portfolio that might best suit your investment goals.

Using normalised average long-term expected returns for key asset types, we calculate the expected average returns for each portfolio and then a spread of likely outcomes either side of that average.

These projections are based on the estimated returns for a portfolio of equities and government bonds, in different percentages, depending on your chosen risk level. In general, the higher the risk of a portfolio the greater the proportion of equities – both in the UK and overseas – and so a higher level of expected return.

For example, a typical risk model 6 portfolio at Nutmeg would contain around 60% equities, with 40% in bonds and cash.

Expected returns from equities

For UK equities, we currently project the long-term (ten years or more) average annual return to be 6.8%, and for international equities, 7.2%. These and other equity estimates are based on combining three elements:

  • historic return volatility
  • a conservative estimate of how much return can be expected for each unit of volatility – very experienced investors will recognise this as the ‘information ratio’
  • an estimate of the future return from the riskless cash rate.

Expected returns from bonds

For bonds, we currently estimate UK gilts will return 3.5% over the long term, while those maturing within five years (shorter maturity bonds) can be expected to return 2.5% (again, over the very long term).

Intuitive logic implies (and historical evidence shows) that long-term bond returns equate to the long-term average economic growth rate. We make estimates of future economic growth that can be corroborated by official government projections.

Shorter maturity bonds earn less because they’re less risky. Experienced investors will recognise this difference as the ‘yield curve’, which needs to be a positive difference to account for the greater risk in holding the bonds over the longer maturity.

In the long term, the return on cash is close to the return on the shorter maturity bonds, so this return is also used as the third element of our equity return estimates.

They’re normalized returns

Bear in mind that these equity and bond projections are expected long-term average normalized returns. As such, they shouldn’t be interpreted as indicating that this return may be achieved in any one year.

Data sources for calculations

We use various third-party data sources to help us calculate the projected returns.

We source historic return and macro-economic data (for 1990-2016) from Macrobond Financial Ltd, and our economic data comes via government data collection agencies.

We use MSCI’s Total Return Index data for equity indices, while bond return indices include FTSE (UK Gilts), Barclays and Merrill Lynch (UK Corporate Bonds), and JPMorgan (Emerging Market ‘Hard Currency’ Bonds).

Finally, we use the International Monetary Fund’s long-range forecasts to sense check our own views about expected long-term economic growth.

Fees, tax and dividends

Our investment projections are net returns after subtracting fees (Nutmeg’s management fee, plus the underlying fund costs).

We also assume that income is reinvested and that any monthly contributions are maintained. The forecasted returns do not include the effects of tax on your investment income, tax on capital gains, of changing your risk profile, or of future changes to our investment strategy.

It’s also important to remember that investments can lose value as well as gain, especially when viewed over a short time period, and the investment journey can feel quite bumpy and unsettling if you’re not prepared for the potential volatility. So, long-term projected returns are unlikely to be consistent from month to month or year to year.

Updating projected returns

Expected asset class returns are long term in nature. While we don’t expect to change them often, we do check in every year to ensure the estimates remain realistic.

Portfolio performance expectations are (in addition to the individual asset return expectations) also based on our benchmark asset allocations across the low-high risk spectrum. We don’t expect to change these investment benchmarks either from year to year, but we do check in annually to ensure they remain appropriate to their design criteria.

Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.

Brad Holland

Brad Holland

Brad is Nutmeg’s senior investment manager. A veteran – 28 years at last count – in financial markets, he started his career as a professional economist at the Australian Reserve Bank. He now specialises in economic and financial market strategy within investment management. Brad studied post-graduate quantitative economics at the University of Queensland, Australia. Despite living in London for 20 years now as a naturalised British citizen, he’s still not quite ready to support England-v-Wallabies.


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