Worried about your investments in equities?

Very little of the general equities market and economic commentary on LinkedIn is positive about the prospects for either. Typically, there are concerns about pricing or earnings’ growth for the former and government/household debt or economic growth for the latter. These are genuine grounds for concern, but it is important to have a proper perspective on prospects for the investment markets.

1.       Part of that perspective is relativity. By most, if not all, measures, the returns on equities are higher than those on government bonds, cash, and alternatives. Of course, that is a generalisation, and I am certainly not suggesting that you place all of your investment capital in equities. Cash provides liquidity and the range of asset classes provides diversification. These are costs worth enduring for their benefits – in moderation. But you should not have your main long-term investments in anything other than listed equities unless you have so much capital that you do not really need more i.e capital preservation is your main objective.

2.      Part of that perspective is accepting risk. There are always risks in investing. Indeed, I am heartened by the negativity of the comments: I assume that these investors are substantially or wholly out of the market. That represents capital waiting to come in when the market falls which, of course, it will do at some time. The easiest way to avoid that inevitable fall is to be permanently out of the equities market, but that means that you will also lose all of the upside which is, on average, proportional to the time that you are in the market. It is true that many markets are close to record highs but markets tend to be close to highs for much of their time.

3.      Part of that perspective is the target return. If you believe that the market is over-priced, then you expect the returns in the future, from current pricing, to be lower. One solution is to accept that as a reality, rather than expecting everybody else to suddenly realise that and start selling so that you can buy at lower prices. Instead, set yourself a reasonable long-term target return – I would suggest 5% to 7.5% p.a. and then find stocks that have a very low beta but an high prospect of achieving that target. You will be surprised how easy it is to do that with high-yielding stocks, albeit that there is a much thinner market in stocks with a beta of close to zero. That will make your portfolio defensive.

4.      Part of that perspective is accepting short-term volatility and loss. Analysts will describe volatility as risk. There is, of course, an inference that volatility risk is bad although, in reality, it represents the prospect of a gain as well as a loss. But investors are much more concerned about a permanent loss of value. That can happen if you sell when markets are down. But, if you do not, then all falls eventually correct and recover. Of course, some individual stocks will never recover, but that is why you have diversification. The biggest risk is that stocks stay depressed in value for a long time; that is where the dividend income will tide you over; indeed, that is what provides most of your returns over the long-term anyway.

5.      Part of that perspective is accepting the statistical evidence. Markets rise more than they fall. You may be smarter than the average investor, and get your timing better than average, but don’t expect to beat a toss of a coin. If you just believe that the fall will come ‘soon’, you are picking a random target; you might have had that expectation for the last five years. More investors sell too early rather than too late and a loss of opportunity is usually worse than a loss in value. The former is often irrecoverable whereas the latter can be just part of a cycle. The 2008/9 recession was a once-in-70 years event. It might happen again tomorrow, but that would be a risky bet even for a speculator.

I appreciate that equity markets differ between countries. My experience is mainly in the UK market. The US market is a high-growth high-price market. The continental European markets are more typically low growth: don’t be fooled by the DAX, which is a total return, not a price, index. You may need to adapt your strategy for local circumstances.