A version of this article originally appeared in April.
Reading the papers, you could often be forgiven for thinking that there had been some sort of disaster in the stock market. You could also be forgiven for thinking that the newspapers were positively willing there to be one.
Headlines like "Stock Market Crashes" and "Tech Stocks Soar" sell a lot of newspapers. Headlines like "Shares Continue to Outperform All Other Investments Steadily Over The Long Term" don't sell a lot of newspapers. The newspapers would have us believe that the stock market is some sort of rollercoaster ride in which fingers are burnt and fortunes made in days or even hours. Unfortunately, thinking like this generally only makes fortunes for the stockbrokers who make commissions on all the trades. The Foolish truth of the matter is that successful investment is a case of being calm, patient and perhaps even a little boring. You have to try to ignore the fact that just about everyone in the media, and certainly all the brokers, are trying to whip everyone up into some mad market frenzy.
I've been having a bit of a look at the CSFB Equity-Gilt Study. As ever, it makes for stunning reading and I should say at the outset that all the figures that I quote from it are the average for a particular investment class and exclude costs. Phew! Now down to business. In the 25 years ending 31 December 1999, equities increased by 149 times. In comparison, gilts increased only 29 times (the figures for cash will be even worse than this). To some extent the strength of these figures is a little misleading, since the starting point is very near the bottom of the 1974 crash. However, even the figures for December 1969 to December 1994, which include the effects of the 1974 crash and exclude the very strong performance from equities in the last five years, show equities increasing 36 times and gilts increasing only 14 times.
Probably the two worst 25-year periods that you could take are the ones which end with the crashes of 1929 and 1974. In the 25 years ending December 1929, equities increased by 6 times and gilts increased only 1½ times (that is, just 50%). In the 25 years to December 1974, equities increased by 7 times and gilts increased a mere 1¼ times (in fact it was 26%). I actually can't think of a period that could make equities look any worse. If any of you Fools can, then let us know on the personal finance discussion board.
Overall, £100 invested in equities in 1869 would now be worth £20 million (or nearly £500,000 after knocking off inflation). £100 invested in gilts would now be worth just £39,000 (or less than £1,000 after inflation). It is pretty clear, then, where your money needs to be if you want to maintain or increase its real value over the long term.
Regular Savings
In fact, it gets better. If you are saving over a period, then you are likely to be adding an amount, say, each month. This has the effect of smoothing out the peaks and troughs in the market and making it even more likely that you'll do better from equities than other investment classes.
This all comes down to the concept of "pound cost averaging". Imagine that you are saving £100 per month into an index tracker. At the start of the year, the units in the tracker are priced at £1 and the index that you're tracking doesn't move for six months. After six months, the index crashes and the unit price falls to 50p, where it stays for the rest of the year. In each of the first six months of the year you will have bought 100 units and in each of the last six months of the year, you will have bought 200 units. By the end of the year, you have therefore bought a total of 1,800 units for a total of £1,200 at an average price 66.6p.
OK, so the unit price is still only 50p and you're not feeling too happy about them being "down" 25%. However, if the index stays at this lower level (or even falls further), at least you know that every month you're buying new units at the lower level and your average unit cost is therefore falling. Of course, if the index rises then you have to pay more for next month's units, but that's OK because all your other units will have gone up too.
It's easy to be seduced into thinking that there is some great advantage in the fact that you buy more units when the price is cheaper. This is, in fact, is just the way the sums look. What matters is how much you invest, not how many units it gets you and, in the example above, you are investing the same £100 when the market is high as you are after it has halved. Even so, the benefits of regular saving, in terms of smoothing out your returns and reducing risk, should not be underestimated.
The CSFB study kindly produces some figures which show the effects of regular savings over the last 30 years. If you invested £100 in equities on the first day of every year since 1970, your fund's value would now have reached £88,315. £100 invested each year into gilts would have got you up to £30,328 and cash would have got you to £17,644. After inflation, the figures are £21,236, £8,693 and £5,376. Again, a pretty ringing endorsement for equities.
What is most interesting about this section of the report, however, is that it demonstrates the relative irrelevance of market timing. Imagine the same scenario as before, where you save £100 per year since 1969. However, this time, instead of investing it on the first day of each year, imagine that you actually invested it on the worst possible day in each year. In other words, you found the peak of the market in each year and, for some sad and obscure reason, you choose that day to invest your £100. Pretty damn unlucky but, even in this scenario, equities win hands down over the long term. After five years (ending with the 1974 crash), your equity fund would have stood at £246, with gilts at £407 and cash at £650. After this, though, equities never look back. From the sixth year onwards, the equity fund is always ahead of cash and gilts and, after the full 30 years, the equity fund would be worth £74,302, the gilt fund £22,921 and the cash fund £17,644.
So, next time the stock market is flying all over the place, the answer is to keep calm, relax, have a nice cup of tea and think to yourself "I wonder what price things will be next month when I invest my next lot of savings". Now that's Foolish.
Questions and comments on this article should go to the personal finance discussion board.
Related Links
The CSFB Equity-Gilt Study
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