Investing fundamentals – will it be all right on the night?

Most clients, most of the time, have the greatest exposure to stock markets through the UK or overseas, typically a bit of both. There are times, and now feels like one of those times, when it is good to revisit why this makes sense.

 

Below we look at why investing makes sense at all, and the very compelling returns in the long run. More importantly, we draw out the wrinkles which occur regularly, and those much larger risks, the possibility of which you must not ignore. 

 

 

If you buy shares in a company you are buying into the dynamism of that enterprise, a company which provides employment to people just like you and your family. Philosophically we could even say this is more than merely investing for your own ends, it is engaging with the world around you – not just for your good, but for the greater good.

 

Whatever your precise justification for investing, the long run returns are impressive in their own right, and equally impressive when compared with alternatives.

 

Below you can see how much money you would have made in stock markets per year since 1900, compared to the alternatives of government bonds and cash, and in particular against inflation, the scourge of long-term inflation (table 1).

 

 

If you also re-invest the income you receive (e.g. dividends in the case of the stock market) the long-term impact is very powerful. Below you can see the impact of re-investing income on an investment of £1,000 made in 1945 (table 2):

 

 

 

 

The argument for investing in the stock market to the exclusion of all else appears to get even better when you then take into account the likelihood of your making positive returns the longer you stay invested. 

 

For example, if over a 10-year period of investing you didn’t perform better than cash, you would feel very unlucky as the likelihood of doing better is 91% - based on 115 years of data (table 3).

 

There is no 20-year period when you would not have done better than cash – and 20 years is a typical period for lifetime investing.

 

 

 

 

The preceding facts represent impressive evidence on the attractions of investing. Yet they can be a mis-leading veil over the unpredictability of investment returns.

 

It was once believed there were no black swans in the world – in fact as far back as the 2^nd century it was an expression used to describe that which was impossible. Then in 1697 Dutch explorers “discovered” black swans in Australia. Now it is more commonly used to describe the bias of those who believe something can never be, either through limited imagination or limited experience – and this combined with an unhealthy belief in the certainty of their world.

 

Over the years we have frequently heard the refrain that “the markets always recover”. Perhaps. Perhaps based on limited experience, albeit even over 30, 40, or 50 years. But you MUST allow for The Black Swan.

 

 

Tables 1-3 conceal periods which were very worrying for investors who lived through them, and they also hide possibilities beyond their bounds.  They take no account at all of the risks for which there might have been no precedent in our investing experience, yet which, if they occurr, would destroy your life plans. 

 

How about our grandparents’ experience? Would they have guessed that their lives would be consumed by two World Wars and The Great Depression? Sometimes fate is just going to deal you a tough hand – and you have no idea it is coming.

 

How about Japan? Their stock market has been down for nearly 30 years. It suffered falls of 80%+ at worst, and is still down nearly 50% - after 30 years! If you were living in Japan in the late 1980s you probably had most of your investments in Japan, your home market – your financial plans were devastated.

 

Ignoring those big risks for a moment, here are some statistics with regard to what has actually happened to punctuate the unruffled journey implied by tables 1-3.

 

All of the above relates to the UK stock market, but it is very similar for the US, the pivotal world stock market.

 

 

The market is brutal in confronting investors with the fact that they are often wrong. It will always probe for basic human weaknesses – greed, fear, and vanity.

 

The point is not to get complacent about stock market returns, nor your ability to decipher them in advance. They won’t be delivered to you in a nice neat package with a ribbon, which happens to coincide with the timing of your life plans.

 

 

This is art not science, broad strokes not fine detail.

 

The pivotal US stock market is now as overvalued as 1929, and on some measures more so. The quantity and quality of global debt has never been worse. That this has been the case for a small number of years already must not make you complacent – as said above, the market is brutal in stripping bare any weakness of yours.

 

Do let us know if you are comfortable accepting these risks head on – for example, with no higher than usual cash margin, or no wish to apply a stop-loss. Some of you might be this comfortable with these investment risks, depending on all of your circumstances. For everyone else, we continue to recommend a sizeable cash buffer. When the time to fully invest comes (it should be obvious at the time) we will all have some fun picking up bargains.