About investment risk
Past performance is not a guide to future performance. But history is a good place to start to explore how well different asset classes have performed over long periods, and what can go wrong. Providing you take a sufficiently long view, the probability of equities or shares providing better returns than bonds or leaving the money on deposit is very high.
Over longer periods a key issue is whether the returns from any of these asset classes also beat inflation. The CSFB Equity-Gilt Study considered every 10 year rolling period since 1879. Equities did better than inflation 87% of the time, gilts 60%, and cash 65%. So the case for investing in the stock market is clearly compelling.
But you must also understand how things can go wrong
Contrary to the perception of many that were new to investment in the decade up to 2000, stock markets go down as well as up; the bear market of 2000/2003 being a rude re-awakening, reinforced in the Autumn of 2008. From 1918 to 1977 you would commonly have seen one year in three with the stock market declining, falls of 20- 30% being commonplace
The bear markets of 2000-2003 and 2008-2009 were perhaps a reminder that the volatility prior to 1977 was the norm. But through all of these ups and downs the long term trend remained up, you just needed patience. The average downturn (bear market) in the US stock market since 1875 has produced a fall of 32% from peak to trough, and lasted 18 months. Patience got you through the average downturn.
Given that equities outperform deposit returns 92% of the time over 10 year periods, you could feel quite unlucky having lived over the last 10 years. Yet it has not been as bad as some analysis would have you believe. For example, over the last 10 years the FTSE All Share Index is down 5%, compared to a 90 day deposit return of 29% (according to Moneyfacts).
But this is distorted. If dividends were reinvested the index was up 35%. Not great, but it could have been worse. And it was a considerably better outcome for investors that bought some of the most popular stock market-linked funds e.g. Newton Higher Income is ahead by 72%, and Invesco Perpetual Income was up 119%.
You could be this unlucky – the accidents of history
You can easily factor into your thinking occasional years of weakness such as just described, as these can be dealt with by patience and a sensible timeframe for investment. But very occasionally, perhaps once every few decades, it can get somewhat worse.
In real terms (that is after allowing for inflation) the US stock market peak of 1929 was not regained until 1954 (25 years), and the peak of 1966 was not exceeded in real terms until 1995 (29 years).
We call these “accidents of history” (what Nassim Taleb has more recently called “black swans”). If you had invested in 1970 could you really have envisaged that oil prices would quadruple in the years just after? No. Nor could some of our parents and grandparents have guessed that their lives would be consumed by two World Wars and a depression. Sometimes fate is just going to deal you a tough hand.
Put together with what occurred in markets in 2008, this is all quite scary. But context is required. For example, after the 1929 peak the trough for the US stock market was in 1932, a bear market of just 3 years. With 1999/2000 being the all-time peak for most stock markets, it can be argued that this downturn has already lasted 11 years.
That being the case, are we more likely to be in the middle or nearer the end of this downturn?
Fingers crossed it is the latter. But we must acknowledge some research that tells us long term, secular, bear markets last an average of 16 years - this fact alone should ensure that we continue to take care.
To provide balance, it must also be made clear that stock market investment has provided superb returns over long periods.
the rewards - they’re very significant
For example, £100 invested in the stock market in 1945 has grown to £119,233, with dividends reinvested (Source:Barclays Capital, 2010). If you had alternatively invested into gilts or left your money on deposit the comparative values would be just £5,087 or £6,133 respectively.
what next?
Now you’ve read a little more about investment risk, you need to understand how this relates to funds. You can also contact us to get more information about how we can help advise you about investment risk – or get hold of a hard-copy of our TopFunds Guide with more in-depth information.