The case for long term investment in equities

Posted by Liz Rees in Risk & Diversification category on 22 Jun 15


Longterm

One of the more difficult decisions we make with regards our money, is whether to invest in the stock market or keep our money in cash.

Of course, unless you enjoy the thrill of chasing a profit by playing the markets, investing is predominantly a means to an end – a way of potentially providing a suitable return on our money to beat inflation, for our retirement or a key purchase during our lifetime.

It’s always worth a reminder on why we invest.

Taking the 10 year period from the start of 2005 to the end of 2014 we can compare the cumulative returns from UK equities against cash as follows:

Returns comparison

When we consider the impact of inflation the returns on cash savings have been very low in real terms over the decade. In fact the average base rate over the period has been very similar to the average inflation figure, at around 2.7%. Furthermore, in recent times it has been very difficult for savers to find a deposit account that provides them with an inflation- beating return. Meanwhile, so far this year the FTSE All Share has delivered a total return of 6.8% while the FTSE All World index has advanced by 5.1% (both in GBP at 12 June 2015). The best performing major global market over this period has been Japan while the US has lagged behind somewhat (the Nikkei has risen by 13.7% and the S&P by 4.7%).

With equities showing greater volatility than for some time it might be useful to review the argument for long term investors remaining invested in the stock market. Concerns about slower growth in China and a Greek debt default have unsettled some equity markets while bond markets have experienced turbulence on expectations that a strong macroeconomic pick-up in the second half of 2015 will result in higher interest rates sooner rather than later. However, corrections are a normal feature of stock markets movements and can occur at various stages of long term bull markets. The fear of short term losses can lead risk- averse investors to reduce their exposure at what could prove to be poor timing, but by spreading investments geographically and across asset classes we can reduce the risk of under-performance in one area.

Much research has been done on whether ‘timing the market’ or ‘time in the market’ is the best tactic to adopt. We would all like to think we can judge the best time to invest and when to switch asset classes but even the experts don’t get it right all the time. Some of the biggest market moves can occur in a short period of time and when least expected so being out of the market when this occurs can cost you dearly. Trying to time the market incurs a greater element of risk- you could get it right and do very well or get it wrong and miss out on significant returns. On a 10 year view statistics have shown that investors who committed money at the beginning of each year were only slightly behind, in performance outcomes, those who successfully time the market but well ahead of those who got their timing wrong. Regular investors were slightly behind those who invest early. At the bottom of the performance league are those who left their savings in cash. The longer the time horizon you invest for the more advantageous it is to remain fully invested as you are able to ride out market fluctuations and enjoy the benefits of compounding dividend growth.

JPMorgan Asset Management investigated the effect on an investor’s returns if they missed a few of the best days in the market. They found that if an investor stayed fully invested in the S&P 500 from 1993 to 2013, they would have had a 9.2% annualized return. However, if they missed just the ten best days during that same period then those annualized returns fall to 5.4%.

JPM chart

Many successful investors take advantage of volatility to buy quality investments during episodes of market weakness. The buy and hold strategy of well known investors such as Warren Buffet and Neil Woodford will mean they often use setbacks to add to their long term holdings.

In conclusion, a lower risk strategy would be to stay invested rather than trying to time the market, while ensuring that you have a well diversified portfolio appropriate for your risk profile. The longer you remain invested the greater chance you will have of achieving your investment goals. However, for those who feel uneasy about market valuations in the short term, an alternative is to undertake regular contributions into an equity product. This approach, known as pound cost averaging, is a useful way of taking advantage of periods of volatility. It helps smooth returns, means you buy more units if the price falls and less if it rises and reduces the risk of committing all your money just before a correction. Our monthly investing page will explain this in more detail.

Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.

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