The following is an extract from last week's regular feature in the Personal Finance section of the Independent On Sunday. Be sure to pick up your copy this Sunday.
Anyone Remember Inflation?
On Wednesday, the Bank of England decided to keep base interest rates on hold, at 5.5%. To your average Fool, this is pretty unexciting news, but it does have some relevance to the overall direction of the stock market.
Do you remember inflation? A the cost of pint of milk used to go up once every couple of months. You got annual salary increases of more than 2% per annum. Your mortgage interest rate was in double figures. The building society would pay savers a decent rate of interest. Those days, for the time being at least, are gone.
This also has an effect on the valuation of the stock market. Day after day, week after week, we are told that the market is overvalued. Price to earnings ratios are at an historical high, and dividend yields are at an all time low. This, the Wise experts tell us, means the market is riding for a fall.
They may be right. Things could all go horribly wrong, and the market could crash in such a fashion that it would make 1987 look like it happened just for fun. A 20% fall in the market in one day would see the FTSE 100 trade at about 4800. For those Fools with memories that go back 5 months, that's where we were at the beginning of October 1998. That perhaps puts a crash into some perspective. It wouldn't be the end of the world.
The lack of inflation, and therefore low interest rates, has a positive effect on the valuation of the share market. Never before have we lived in such a low inflationary environment. In years gone by, apart from the share market, there were other quite attractive options for people to invest their money. A no-risk deposit in a bank, building society or government bond would yield an investor upwards of 10% interest per annum. When you compare that with buying shares, where the historical returns have been about 12%, you can see why investors weren't so keen on the share market. The additional risk involved was just not worth it, particularly when you consider that by buying shares there's a chance of losing all your money.
Today, the benchmark 10 year government bond yield is about 4.4%. You are lucky if your building society pays you much above 4% interest on your savings. Suddenly the share market, with its historical 12% returns, looks an attractive option when compared to the risk free rates of return on offer. This is a complete reversal of the situation described in the above paragraph.
This fact has not gone unnoticed and is one of the reasons the market is at high historical levels. In fact, it could be that over the next 5 years, the stock market will not match the long-term growth performance that it has achieved in the past. Is this a reason not to invest in the market right now? We Fools think not.
Warren Buffett, the world's greatest stock market investor, last week said, "You know that valuations are high by historical standards. You know that the level of speculation is high by any historic standard. And you know that that doesn't go on forever. But you don't know when it ends."
The last sentence is the clincher. If you are sitting on the sidelines, waiting for the crash, you could be waiting a very long time. You may never invest in the stock market. Investing when the market has fallen, and is still falling, is much harder to do than it sounds. Don't underestimate the tricks your mind can play on you. In a bull market it says, "I can't invest now, because there's a crash coming just around the corner." In a bear market it says, "I can't invest now -- I'll just wait for the market to bottom out." Invariably, the crash never comes, and by the time you know the bottom has been reached, it's too late to invest in the market. We went through this scenario in the middle of last year.
You can invest in the share market, and you can do so now. A monthly contribution to a low cost index tracking fund means you can drip feed money into the market over an extended time period. If the market does turn out to be at its peak, you avoid putting all your money in at the top. But, before you do that, we'll leave the last word to Mr Buffett, who is undoubtedly a Fool: "You shouldn't buy on borrowed money. You should pay off all credit card debt before you buy any shares, because you're paying 18 percent on credit card debt and you're not going to make more than 18 percent a year in the market."
My Smartest Investment
I took a closer look at the annual statement I received from my pension provider and was horrified to find that the return I was getting was barely more than I might have expected from a building society. Of course, this was due to the double whammy of the effect of high charges and poor performance. I have now transferred to a low cost index tracker pension from a "direct" provider, which gives me low charges, total flexibility, enhanced performance potential and (best of all) obviates the need to consult (and pay in the form of commissions) a so-called independent financial adviser. -- A.L., London
The Fool responds: What more can we say? You are now a true Fool. The best person to look after your financial affairs is YOU. Only you have your best interests at heart. So called "Independent" Financial Advisors have to make a living, and that comes at the expense of the individual. An index tracking fund will see you beat the investment returns of about 90% of unit trusts.
Trivia Quiz
This company is best known for their hand held computers, but it is now losing ground in that very competitive market. Last year the company initiated a joint venture named Symbian, through which it hopes to develop the industry standard operating system for wireless communication devices. Symbian is currently loss making, but the company hopes the investment will pay off in the new millennium. Name this company and one of the other companies involved in Symbian.
(Last week's answer -- Unilever, Co Chaired by Niall Fitzgerald and Morris Tabaksblat)
Ask the Fool
Hi Fools,
I'm interested in a company called Easynet. I would like to know how I could find information about the company. -- R.F., London
The starting point to find out information about any company is to contact it direct. Easynet's phone number is 0171 681 4444. For starters, request the company's annual report, which tells you what the company does and what it sees as its prospects. The annual report also has the three key accounting statements -- profit & loss, cash flow and balance sheet. After that, if you have access to the Internet, it can be a wonderful source of information. The company has a website (www.easynet.co.uk), and you can swap thoughts with other investors at the Motley Fool's message boards. Finding out more about the company's competitive environment might help you decide whether it is a sound long-term investment.
