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Newsletter  23/04/2019

An eye to the future - investing for the long term

Marcus Brooks emphasises the need for investors to take the long view.

THE FINAL QUARTER OF 2018 proved to be a tumultuous one for equities and other risky assets as the threat of rising interest rates, slowing economic growth, trade wars, and political instability across the world caused a bout of volatility. Indeed, the months of October and December 2018 proved to be some of the worst since the financial crisis over ten years ago.

At times such as these it may be tempting to question the wisdom of investing in equity markets with the nominal security of retaining the funds in cash alluring especially given the recovery in global equity markets over the last few months.

...as the setback in the fourth quarter of 2018 showed us, investment in anything other than cash should only be undertaken with a medium to long term timeframe.

Usefully, it is about this time of year that the annual instalments of the publications detailing the long term returns from various asset classes are produced and even a brief perusal of these should cause one to think twice before acting precipitously and liquidating portfolios.

Statistics from the Credit Suisse Global Investment Returns Yearbook 2019 show that the real (after inflation) annual total return (capital and income combined) from US equities stretching back to 1900 has been 6.4% (US Bonds 1.9% and US$ Cash 0.8%). The equivalent figures for the UK are 5.4% for equities, 1.8% for bonds and 1.0% for cash respectively.

These statistics, combined with recent volatility, serve to highlight a number of important lessons about investment. The first is that, based on historical statistics, the case for investing in equities is compelling. However, as the setback in the fourth quarter of 2018 showed us, investment in anything other than cash should only be undertaken with a medium to long term timeframe. This is because statistics also show that from most starting points the chances of making a reasonable real return from equities over a ten year period are good but become less so as the timeframe shortens.

The second and related lesson is that market timing successfully is difficult and endeavouring to attempt it might well be costly – missing the twenty-five best days in markets over the last fifty years roughly halves the annual return achieved and since when those days will occur is unpredictable, remaining invested for the long term is probably the best strategy. Losses are only losses when crystallised, which is why we, as investors in UK equities, focus more on the possibility of permanent loss of capital rather than on the short term direction of a share price when investing.

This is not to deny the benefits of a diversified portfolio, although, for the very long term investor,  equities would seem to be the best place to invest. Real annual returns from all three major asset classes are positive and thus it follows that using all three to adjust the annual volatility according to risk appetite can still produce an acceptable real return, while it still probably makes sense to adjust portfolios tactically to take account of shorter term economic conditions and market anomalies. As an example, holding cash today almost guarantees a negative real return over the next year so, given the above, putting it to work for the long term should prove profitable whatever politics or markets have to throw at us.

Marcus Brooks

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