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THE INVESTOR | 13
ECONOMY
IN YOUR INTEREST
In 2013 – long before the latest bout
of stock market turmoil – a team of
behavioural economists at Barclays
produced a paper with a highly
intriguing title: Overcoming the cost
of being human.The thesis argued that
investors are their own worst enemy when
they allow emotions to get the better of
their reasoning.
People often make less than they should
from investments by buying or selling at
the wrong times. In fact, they often make
avoidable and unnecessary losses when
they become panicked and reverse
investment decisions prematurely. It is part
of our genetic make-up to react quickly to
fear, which is why so many investors,
having bought the right funds for the long
term in a period of calm, then sell them at
the first sign of market turmoil.
It can happen to anyone. During the
opening weeks of 2016, when a market
meltdown came out of a clear blue sky,
it made even hardened market professionals
take decisions based on fear rather than
logic. However, all the statistics of long-
term trends show that if we could curb our
fear, we would be much better off.
The Barclays paper contains a heat map
of movements in the MSCI World Index
of 24 developed world stock markets for
the 40-year period from 1970 to 2010 –
the index is a proxy for a geographically
diversified share portfolio.
This analysis shows that four-fifths of all
losses are incurred by investors with a
holding period of less than five years.
However, investors who were willing to
ride out initial volatility and hold on for 12
years made a profit, whether they bought
originally at a market peak or a market
trough.Trying to time the market, by
buying in troughs and selling at peaks, has
little long-term value because the highs
and lows become less relevant with the
passing of time. Periods of market turmoil
– such as the 1987 crash, or Black
Wednesday in 1992, when the UK
was ejected from the Exchange Rate
Mechanism – barely show up on a chart
of long-term trends.
Three of the recognised global
authorities on long-term investment
returns are London Business School
academics Elroy Dimson, Paul Marsh and
Mike Staunton.They compile what is
known as the DMS database1, published
every year by the Credit Suisse Research
Institute.The message of their work is that
the essentials of success are to hold for the
long run and have a
diversified portfolio.
There are, however, no
absolute guarantees.
Indeed, this year’s
database illustrates the
truth of comments
made by the great
economist John
Maynard Keynes, who said that markets
might remain irrational longer than
investors can remain solvent. Hence the
key question: when talking about the long
term, how long do we mean?
The Credit Suisse study helps here. It
shows that in the UK, from 1900 to 2015,
shares returned an average of 5.4% per
annum, while bonds delivered 1.7% and
cash 1%. However, it also underlines that
there can be periods of underperformance,
like the one we are currently living through.
Looking back, we can now see how spoiled
we were in the 1990s: the Credit Suisse
report shows equities delivered 11.5%,
bonds 9.7% and cash 4.6%.A long-term
focus is essential, but some long-term
investments are better than others.
The figures also underline the need
to diversify because individual markets
can go sour for very long periods. Japan is
the obvious contemporary example. Its
stock market, the Nikkei, peaked at 39,000
way back in 1989 2 before falling more or
less steadily to around 9,000 in 2002.
While it has got back above 20,000
on several occasions in the past quarter
of a century, it has generally fallen back
and never come even remotely near its
all-time peak.
Few investors like these periods of
volatility, but they are becoming more
frequent, as innovation makes it possible to
deploy the world’s capital at the touch of a
button.The mood swings of the markets
when they think the economy is slowing,
or that an oil price shock will be damaging,
are more dramatic than they used to be
because globalisation means markets are
far more
synchronised.
Advances in
technology mean
that investors can
deploy more
money more
quickly, as their
fear dictates.
Where investor behaviour may have
caused light ripples in the markets
30 years ago, now it can create tidal waves
around the world.
We may not like it, but we have to learn
to live with may not like volatile
markets but in truth we have to learn to
live with them. History is firmly on our
side in suggesting that the stock market
should be home for a reasonable
proportion of our money. Coping with
volatility is the price we have to pay for
the prospect of good long-term returns.
Patient investors, with a diversified
portfolio of assets, should be able to ride
out the volatile storm.
1 Credit Suisse Global Investment Returns
Sourcebook, 2016
2 2016
Balance sheetWe need to act against our instincts,
hold fast and trust the historical record of long-term
investments in order to see a decent return on capital.
Periods of market
turmoil barely show
up on a chart of
long-term trends
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