Investing ….. when things go on sale, people run out of the store.
“Investing is the only business I know that when things go on sale, people run out of the store.”
– Mark Yusko, Chief Investment Officer, Morgan Creek Asset Management
Investors would be easily forgiven for harbouring an element of apprehension when it comes to investing in stockmarkets. After all, financial history is fraught with bubbles, follies and panics – all with varying levels of severity.
By nature, stocks (aka equites) are risky investments relative to other major asset classes. This is due to the fact they are the lowest-ranking component of a firm’s capital structure. Put another way, equity investors are last in line to receive the net proceeds of a company in the event of liquidation.
This may prompt questions as to why one would invest in such a risky asset. The answer according to decades – and in some cases centuries – of empirical evidence, is that over the longer term, investors are compensated for taking on that risk. Equities may be last in line in a liquidation scenario, but they are first in line when it comes to receiving a firm’s net profits or, in accounting parlance, ‘earnings attributable to shareholders’.
To illustrate this point, we provide the below chart which shows annualised risk and return data for cash (GBP), global bonds (GBP-hedged) and global equities. One can clearly see that global equities have produced a far greater annualised return than global bonds (which are debt instruments and offer no profit-participation) and cash. It is also evident that equities come with a commensurately higher degree of risk. The amount of return investors require to own equities over ‘risk free’ assets (such as shorter-dated developed government bonds or cash) is known as the Equity Risk Premium.
Given the inherent risks associated with equity investing, and the fact that global stockmarkets have (generally speaking) enjoyed a long-running period of strength since the depths of the Global Financial Crisis in 2009, many of our clients have expressed concerns about when this run will come to an end and, if so, how pronounced the downturn may be.
Readers of our previous publications will know that we do not consider ourselves to be able to predict the future, nor do we place much faith in those who claim to be able to do so; however, as students of financial history, we offer the below points to our readers in a light-hearted manner:
- Will a market correction occur at some point in the future?
- How certain are we of this?
- What will the magnitude of this correction be and when will it occur?
We cannot be sure.
- Given the above points, is there anything investors can do to increase the probability of earning a positive return?
Yes – we believe the most effective tools investors have at their disposal when it comes to a successful investment strategy is the discipline of remaining invested over the longer term.
We provide the below logarithmic chart as evidence of this phenomenon. It displays the value of $1.00 invested into the S&P 500 index from 1926 to date – assuming no reinvestment of dividends. Although 91 years is certainly well beyond what would be considered a ‘normal’ time horizon, it serves to illustrate our point as the initial $1.00 investment would be worth approximately $6,750 today.
We have highlighted various crises and calamities along the way which (to put it lightly) were at the time the cause of significant stress to investors, especially the more risk-averse genre; however, when these events are presented in context over the longer term, these drops appear much less pronounced and are more akin to speed bumps as opposed to cliff falls. It is also evident that the constantly invested individual would have been handsomely rewarded for riding out these periods of volatility.
This may not come as any relief to investors with time horizons less than 91 years and, with that in mind, we will examine evidence which focusses more on the modern era.
Take for example the below chart representing a hypothetical investment of £10,000 into the FTSE All Share Index between 1996 and 2016 with dividends reinvested along the way:
The blue column represents the constantly invested individual, who achieved an end value of £42,500. The proceeding grey columns represent individuals who became completely disinvested for various periods of time and were unlucky enough to have missed the best 10, 30 and 50 days of index performance respectively. Even the investor who ‘only’ missed the 10 best days ended up 46% worse off than he or she who held their nerve and remained invested throughout the entire 20 year period.
A final piece of evidence we offer focusses on market timing – a skill many active managers today claim to possess based upon their predictions of the future. The below chart displays the end-wealth of 5 investors who followed separate strategies when investing into the S&P 500 index, with one individual avoiding the market altogether and remaining in cash throughout the entire 20 year period.
Were one able to consistently achieve perfect market timing over the period, this individual would of course be better off versus his or her peers; however, to invest with perfect timing every month over a 20 year period is, frankly, impossible.
The critical message resulting from the study was that even an individual with consistently poor market timing was substantially better off than they would have been had they remained un-invested and had held cash over the entire period. Furthermore – and fortunately – investing a portion of one’s income immediately upon receipt, or at the beginning of each month are investment strategies which can be easily and effectively implemented.
In conclusion, we are very well aware that psychology plays a significant role when it comes to investing. Indeed, this is an aspect of investing to which we assign a high degree of consideration when advising our clients on their respective investment strategies. We believe it goes without saying that one should never invest in something which makes them feel uncomfortable. The above charts and figures are simply intended to provide our readers with evidence which validates a key tenet of the Aspinalls’ philosophy: the longer one can remain invested, the higher the probability of achieving your return objectives.