Investors have experienced a challenging few years as central banks have raised interest rates sharply to tame inflation, leading to losses in bonds¹ and sharp swings in share prices.

While we think interest rates may need to remain elevated for some time to bring inflation under control, there is a silver lining for investors.

A return to a more ‘normal’ environment for interest rates (where they are above the rate of inflation) is a positive development. It should help investors achieve their financial goals, because it will set a solid foundation for long-term returns from assets such as bonds and shares over the next decade, as we explain below.

We look at the outlook for investors in 2024 and beyond and explain why higher rates are ultimately positive for investors.

Outlook for the UK economy

Over the past two years, the UK has witnessed its most rapid interest rate-hiking cycle since the late 1980s. The hikes are starting to hurt the domestic economy and we expect this to continue in 2024.

Despite this slowdown in activity, inflation remains elevated, so we think interest rates will need to stay high for an extended period. We expect interest rates to remain at 5.25% until at least mid-2024, after which we expect the Bank of England to start cutting rates gradually.

Even then, we expect interest rates to remain higher than we have become used to since the 2008 global financial crisis, when rates were at historically low levels. But this is likely to be a positive development for investors.

Rate cuts in 2024, but zero rates are behind us

Notes: Monthly data from January 2005 to November 2023. Forecasts thereafter run to year-end 2024.

Sources: Vanguard calculations, based on data from Bloomberg, as at 30 November 2023.

Thanks to higher rates, bonds are back

There has been short-term pain for bond investors over the past two years, but it may lead to long-term gain over the next ten years.

Global bond prices have fallen (and yields risen)² over the last few years because of the transition to the new era of higher rates. Bond prices tend to fall when interest rates rise because existing bonds paying lower interest become less attractive.

However, higher interest rates should ultimately mean higher total returns for bond investors over time. This is because yields on bonds have increased and will likely offset recent losses.

The chart below shows how our return expectations for bonds have improved substantially since interest rates started to rise.

Read our article for more on the outlook for bonds.

Expected 10-year bond returns for UK investors

Potential range of annualised³ returns over 10 years for UK bonds and global ex-UK bonds

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Distribution of return outcomes in pounds sterling from VCMM are derived from 10,000 simulations for each modelled asset class. Simulations as at 31 December 2021 and 30 September 2023. Results from the model may vary with each use and over time.

Note: Figures are based on a 1-percentage point range around the 50th percentile for fixed income. All projections are in pounds sterling. Benchmarks used for asset classes: UK bonds: Bloomberg Sterling Aggregate Bond Index; global ex-UK bonds (hedged): Bloomberg Global Aggregate ex Sterling Sterling Hedged Bond Index. Hedged means hedged back to local currency to manage currency fluctuations.

Source: Vanguard. 

Outlook for shares

A higher-rate environment can depress share price valuations (which are a measure of how well a company’s share price is justified by fundamental metrics such as its earnings). Higher rates can also squeeze company profit margins as they find it more expensive to borrow. 

Valuations are most stretched in the US, which is why we do not expect the recent outperformance of US shares to continue. The chart below shows our return forecasts for UK and global ex-UK shares compared to those two years ago.

Read our article for more on the outlook for shares.

Expected 10-year returns from shares for UK investors

Potential range of annualised⁴ returns over 10 years for UK shares and global ex-UK shares

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Distribution of return outcomes in pounds sterling from VCMM are derived from 10,000 simulations for each modelled asset class. Simulations as at 31 December 2021 and 30 September 2023. Results from the model may vary with each use and over time.

Note: Figures are based on a 2-percentage point range around the 50th percentile of the distribution of return outcomes for equities. All projections are in pounds sterling. Benchmarks used for asset classes: UK equities: MSCI UK Index; global ex-UK equities: MSCI AC World ex-UK Index.

Source: Vanguard.

What does this mean for my portfolio?

The case for a balanced portfolio (one with a blend of global shares and bonds, such as 60% in shares and 40% in bonds), is stronger than in recent memory, thanks largely to the improvement in the outlook for bonds. In 2021, we expected a less than one-in-ten chance of achieving an annualised return of at least 7%⁵ over the next decade; now, we think that chance is more than one in three.

To look at it another way, in 2021 we forecast that annualised returns over 10 years for a 60/40 portfolio would be around 3.5%, as shown in the chart below. Today, we expect annualised returns of around 6.2% over the next ten years for the same portfolio.

The chart also shows our expectations for portfolios with different blends of shares and bonds, ranging from a portfolio with 20% shares and 80% bonds to one with 100% shares. The portfolio that is appropriate for you will depend on your goals and your attitude to risk.

The projected returns for a portfolio with 100% shares are slightly lower than for a portfolio with 80% shares and 20% bonds because of the benefits of holding a diversified portfolio. While global shares are expected to have a marginally higher return than global bonds, we expect bonds to offer some protection against large downturns in shares. At the same time, and in contrast to the past decade, bonds are also expected to contribute meaningfully to the total return of the portfolio as well as having lower volatility than shares. Taken together, this means that an 80/20 portfolio has marginally higher projected returns than one 100% invested in shares.

The chart also shows that holding more shares increases the range of potential returns because shares come with higher volatility (or swings in prices). The green box represents the middle 50% of our forecasted returns and is larger for portfolios with a higher allocation to shares, representing the larger uncertainty in possible returns for these portfolios.

Remember, too, that projected returns do not reflect or guarantee future results. There could still be some uncertainty in markets going forward as economies adjust to higher interest rates, so there are likely to be years when returns are lower than those projected as well as those when returns are higher. Over 10 years, however, the outlook has improved relative to where it was two years ago.

Expected 10-year returns from different portfolios

Potential range of annualised⁶ returns over 10 years for portfolios with different blends of shares and bonds

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modelled asset class. Simulations are as at 31 December 2021 and 30 September 2023. Results from the model may vary with each use and over time.

Notes: The forecast corresponds to the median (middle point) of 10,000 VCMM simulations for 10-year annualised nominal returns in pounds sterling for multi-asset portfolios highlighted here. The green box represents the middle 50% of our forecasted returns and is larger for the portfolios with a higher allocation to shares. Asset-class returns do not take into account management fees and expenses, nor do they reflect the effect of taxes. Returns do reflect the reinvestment of income and capital gains. Indices are unmanaged; therefore, direct investment is not possible. Equity comprises UK equities and global ex-UK equities. Fixed income comprises UK bonds and global bonds ex-UK (hedged). UK equity: 25%, UK fixed income: 35%. Benchmarks used for asset classes: UK equities: MSCI UK Index; global ex-UK equities: MSCI AC World ex-UK Index. UK bonds: Bloomberg Sterling Aggregate Bond Index; Global ex-UK bonds: Bloomberg Global Aggregate ex Sterling Sterling Hedged Bond Index. Hedged means hedged back to local currency to manage currency fluctuations.

Source: Vanguard calculations in pounds sterling, as at 30 September 2023. Median numbers for the gold bars are as at 31 December 2021.

What does this mean for me?

The change in the outlook over the past few years, particularly for bonds, shows the benefits of sticking to a long-term plan despite the temptation to react to short-term moves in prices. Investors who abandoned markets in response to recent market falls may miss out on the opportunity to make back recent losses in the years ahead.

There are no guarantees, of course, and you may get back less than you put in. However, having a balanced portfolio of shares and bonds across different countries and sectors can help you to ride out short-term swings in performance and improve your chances of long-term investment success.

¹ Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest and return the capital at the end of the term.

² The yield of a bond shows its income as a proportion of its price.

³ Annualised returns show what an investor would earn over a period of time if the annual return was compounded (i.e. the investor earns a return on their return as well as the original capital).

⁴ Annualised returns show what an investor would earn over a period of time if the annual return was compounded (i.e. the investor earns a return on their return as well as the original capital).

⁵ The annualised return for a portfolio of 60% global shares and 40% global bonds from 31 December 2003 to 30 November 2023 was 7.4%. Source: Vanguard calculations in pounds sterling, based on data from Refinitiv.

⁶ Annualised returns show what an investor would earn over a period of time if the annual return was compounded (i.e. the investor earns a return on their return as well as the original capital).