Key challenges when investing for income
Negative real risk-free returns
Historically you could invest in UK Government gilts, or very low risk corporate bonds and earn a positive real return above the rate of inflation even after paying fees. Today, after the long-term effects of the financial crisis and quantative easing by central banks around the world, interest rates on these risk-free investments are so low that they produce lower returns than inflation after fees.
These traditional safe haven assets added to portfolios may produce short term gains, but in the longer term will drag on returns and investors would be typically be better off holding funds on deposit than paying for it to be invested at such low rates.
Lower returns from UK Blue Chip equities post 2000
Having jumped from its starting level of 100 in 1984 to almost 7,000 by the end of 1999, the FTSE 100 has generated much more modest capital gains since the turn of the century.
Uncertain future returns
Most analysts predict that the average return from equities will be around inflation plus 5% each year. Actual returns can be very different for many years. The FTSE 100 is a case in point, where returns have been only 1-2% ahead of inflation for the last 20 years.
Whilst equity market returns might be lower this century than last, volatility has certainly not diminished.
Passive index funds and high frequency trading are possible explanations as to why we still get the boom and bust syndrome in equity markets, but history shows equity markets around the world have suffered two ‘bear markets’, where a market fell as much as 40%, in the last 20 years.