It is widely recognised, and accepted, that real assets, such as property and shares, offer the best home for long-term savings*. However, it is also recognised that both asset classes are volatile.
Of the two, Stock Exchange listed shares are the more volatile as their value is readily identifiable in real time, by dint of their traded share prices; added to which they are more liquid, that is they can be more easily and less expensively bought and sold than property, which contributes to share price volatility. Nevertheless, and notwithstanding the volatility, listed shares have outperformed property, bonds and cash over the longer-term*.
At Killik & Co we have, what we believe to be, a simple and unique approach to maximising the long-term return whilst managing investment risk, which is actually grounded in common sense. It does, however, require close collaboration between the adviser and the underlying investor; which is where you come in.
The heart of our approach is sensible planning. It won’t remove the market fluctuations in the value of a portfolio, but it will largely negate their impact.
Working on the principle that an investor, such as yourself, has sufficient “rainy day money” available, which we define as cash to meet unexpected emergencies, and that all foreseeable calls upon the capital have been identified and provided for; then any other savings should be invested in listed shares, which we call your “Lifetime Savings” (see Figure 1 below).
The logic of this approach is based on the experience of the most sophisticated and mature equity markets in the developed world, being those of the UK and the US. In the post-war period of seventy years, the longest period between a market peak, followed by a trough, followed by a recovery to the previous peak has been seven years, with the average being less than five.
The logic therefore follows that provided one has sufficient “rainy day money”, and that one has identified all potential calls on capital and made provision for them by moving toward cash or short dated bonds, within five to seven years of the need for the capital, you should be able to ride through any equity market downturns.
I was tempted to write “with equanimity” at the end of the last sentence, but to do so would be to fail to recognise the anxiety caused by serious market falls. However, because you will have planned, it should be of less concern to you as you will not need to sell; you can simply put your “tin hat” on and you can afford to wait for better times.
In support of the position of riding through the downturns, I draw your attention to Figure 1 and Figure 2 from J.P. Morgan. The first (directly below) shows the range of performance of the US equity and bond markets over a rolling one year, five year, ten year and twenty year timeframe. This demonstrates how volatile markets can be in the short term, but how the volatility declines over time.
Figure 3 below demonstrates, in the context of the UK equity market, what would have happened to a £10,000 portfolio that remained fully invested between 1996 and 2015, against a portfolio that missed the 10 best days of market performance, the 30 best days and the 50 best days. This simply shows the risks that an investor is taking when trying to trade the market by getting out and coming back in again.
A long-term investor should not attempt to trade the equity market by selling and hoping to buy back at a lower level. In my experience very few investors are able to do this successfully and consistently. The essential principle of the approach that I am outlining is that no one should treat their equity portfolio as a bank account, to be tapped whenever the need arises. If you are taking money from equity markets you must plan to do so in advance.
Another way of looking at this is when we receive this instruction from an investor: “I have a sum of cash that I will require in five to seven years, I would like to put it into the equity market in the meantime”. Depending upon the level of the market at the outset, I would hope that most Investment Managers would respond along the lines that “your time period is too short to sensibly consider equity investment”. The same principle applies.
If you are uncertain as to how much “rainy day money” you might need, or what your foreseeable calls on capital might be, simply increase the bond element of your portfolio to a level that should adequately cover them to a point that you feel comfortable.
Your Investment Manager will be able to advise you, but this is where we need to work closely together as I intimated earlier. You must keep us fully appraised of not just your known monetary needs but also of your future thinking.
I am highlighting this now as the principles that I am outlining become more pertinent as equity markets move into new all-time high territory, which we are currently experiencing.
Now, I would not wish you to think that we are making a call on the market, as we happen to be quite favourably disposed toward equities at the moment. Indeed, we would advise an investor with a capital sum that they did not need for the foreseeable future, in other words lifetime savings, to feed money into equity markets now.
However, in the same way as I would caution anyone investing into the market now on a five year view, as there are always things that can go wrong and the timeframe may be insufficient to enjoy the recovery, I would urge those that are invested in equities to consider their short term cash needs and to discuss them with their Investment Manager.
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*Reference: Barclays Equity Gilt Study 2016