News
Investing: it’s a marathon not a sprint
09/12/2008
DON’T PANIC; LOW SHARE PRICES AND FUND VALUES COULD PRESENT PROFIT OPPORTUNITIES FOR BUYERS NOW
by Ian Cowie, Personal Finance Editor of The Daily Telegraph
Everyone knows that share prices can fall without warning but investors seeking to accumulate capital over the medium to long term should also beware that there are risks associated with being ‘out of the market’ with no exposure to shares or share-based funds.
That may seem counter-intuitive after the stock market’s downward trend in recent years and extreme volatility in recent months. The explanation is that share prices can also rise without warning and some of the greatest gains have been made after the biggest losses.
Investors in the FTSE 100 index of Britain’s biggest companies’ equities - another name for shares - have seen the value of their capital fall by about a fifth over the last decade. It has fallen by nearer a third in real terms if you allow for inflation or the reduced purchasing power of money over that period.
No wonder many investors are giving up on shares and share-based funds. According to the Investment Management Association (IMA), withdrawals from unit trusts and open-ended investment companies (OEICs) exceeded new purchases of units by £1.6 billion in September, the most recent month for which they have figures, compared to a net inflow of £1.1 billion in the same month last year.
According to the IMA, nearly 800,000 Individual Savings Accounts (ISAs) have been closed over the same period - suggesting many investors will suffer a double whammy of turning paper losses into real ones and losing these valuable tax shelters; because you cannot go back to re-open ISAs after they have been closed.
Tempting though it may be to turn away from stock markets in disgust, doing so now could prove an expensive mistake. Long term analysis by Fidelity Investments, one of the biggest unit trust managers in the world, suggests that a ‘lost decade’ for share-based investors is often followed by substantial gains.
Fidelity analysed investment returns stretching back more than a century and divided this period into 99 distinct but overlapping periods of 10 years. Only 19 of these decades suffered as big a loss as the current decade - in two clusters ending in the years between 1915 and 1924 and again between 1974 and 1982.
More importantly, share-based investors enjoyed substantial gains in 18 out of the 19 decades that followed these ‘lost decades’. In the worst case, the only negative result, a £100 investment was turned into £92 after accounting for inflation and disregarding the beneficial impact of dividends. In the best case, the £100 was turned into £268, again after stripping out the illusory uplift of inflation.
The average return for the 19 lost decade investments saw £100 turned into an inflation-adjusted £179. Even if you had spent your dividends as you received them, you would have almost doubled the purchasing power of your money.
But, when the TV news and tabloid headlines are screaming about ‘billions wiped off shares’ it is very difficult to avoid panic. Shorter term analysis by fund managers T Bailey illustrates the cost of following the crowd and selling before prices recover.
Looking back over 20 calendar years of data, T Bailey discovered that missing the best performing day in the markets in each calendar year for two decades, an investor in a fund mirroring the performance of the FTSE All-Share Index would see their total returns more than halved - from 686pc to 340pc.
Most investors will have shorter time horizons than a decade or two but, again, the lessons of history are emphatic. Analysis by Barclays Capital, a subsidiary of the high street bank, shows how share-based investment has tended to produce greater returns than bank or building society deposits over most periods of five consecutive years. The annually-updated Barclays Capital Equity Gilt Study suggests that shares are dangerous for short-term speculators and people who are prone to sell at the wrong time but a relatively safe bet for those who can hold for the medium to long term.
Each year, Barclays Capital analyses and compares returns from a basket of shares reflecting the broad composition of the London Stock Exchange, deposits and bonds going back to 1899. When it divided that period of more than a century into chunks of two consecutive years, it found that shares produced the highest returns in just over two thirds of these periods. In other words, there was a substantial one-in-three risk of being better off in cash.
However, when Barclays Capital extended the period of investment to five consecutive years, shares did best three quarters of the time. Over any decade, the odds on shares coming out ahead rose to nearer nine in 10. And, to put our current crisis in perspective, bear in mind that Barclays Capital’s sample period covered the Great Depression, both World Wars and several stock market slumps. The credit crisis is a grave threat to the global economy but is it really worse than all of those preceding crises?
Many individual investors seem to think so. But those who switch into cash now could be selling at or near the bottom of the market cycle - the exact opposite of the textbook ‘buy low, sell high’ route to profits. The sad truth is that most investors buy when share prices and fund values are high, before selling when prices are low. In other words, they ignore the advice of one of the most successful investors alive today; Warren Buffet. He advised: "Be fearful when others are greedy and greedy when others are fearful."
Of course, nobody knows what will happen to stock markets next week, next month or next year. But none of those factors need matter much if you do not intend to retire or encash your investments next week, next month or next year. The practical solution for medium to long term investors is to maintain a disciplined approach to investment, putting a fixed sum into shares or share-based funds each month. That will minimise the risk of bad timing - or investing a lump sum just before prices fall - while maintaining your exposure to any recovery in stock markets.
It will be emotionally difficult to do for as long as share prices and fund values keep falling. Fear has replaced greed as the dominant sentiment in the stock market and yet that state of affairs is unlikely to last forever. Then, when stock markets recover - as they always have done in the past - this disciplined approach to capital accumulation should pay dividends. Of course, the past is not necessarily a guide to the future but, as another successful stock-picker Jim Slater observed: "In the absence of a crystal ball, history is the next best thing."
Ian Cowie is Personal Finance Editor of The Daily Telegraph. Ian has been a journalist for over 25 years and has edited The Telegraph’s Money section since 1990. He is one of the most respected journalists in the industry, having won many awards over the years, including last year’s Pensions Journalist of the Year (Association of British Insurers) and Columnist of the Year (Headline Money).
We are very proud of our affinity with The Daily and The Sunday Telegraph and many of you will avidly read Ian’s comments each Saturday. Rather than taking our word for it, Ian has written this article specifically for you, where he talks about the long-term opportunities he sees from investing in the stock market and the risks you will take by being out of the market.
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