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August investor update - tree

Over the 40 years to 30 June 2012, the average gross return from global shares, before the impact of currency, was 8.31% a year. Within the 40 years, the returns over the different 1 year periods ranged from -42% to +51%. The variations of the returns over the years ending 30 June are:

August 2012 update Chart 1

By their very nature, shares are expected to go up and down. As can be seen, about ¼ of the years were negative and ¾ positive. This highlights one of the risks with shares that an investor must manage. It is important not to have to sell when the market is down because you need the money. Being forced to sell when the market has just gone down crystallises the loss, which is not a good position to be in.To help manage this risk, we suggest that investors should only invest in shares if they are willing to wait at least a further 10 to 12 years before they sell, should something go wrong. This reduces the need to be a forced seller.

But being willing to wait ten years does not guarantee a positive return. The ten year average returns over the last 40 years have been:

August update 2012 Chart 2

The ten year average returns have generally been above 5% p.a., but not always, and in recent ten year periods the average has been negative.

If we look at returns over 20 year periods, we see a similar pattern of rising average returns throughout periods ending in the 90s and declining average returns since, with the “low” occurring in early 2009.

August update 2012 Chart 3

But what about selling before the market goes down?

One alternative to being willing to hold shares for 10 to 12 years if the market goes down, is to look to sell before the bad years occur. A question often asked is, “why does a manager not sell shares when the market outlook is poor?” The main reason is that most managers, like most people, cannot tell with any certainty when the market will perform poorly. They might know that the market is more expensive than normal, but not when it will fall and become normal. It may be several years before the market corrects and in the meantime you miss out on the returns generated.

Over the 40 years to 30 June 2012, the average return achieved, if you stayed invested for the full 40 years, was 8.31% a year. Assume that with perfect foresight, a manager had the ability to sell-out when the expected return for the next 12 months was going to be below 5% and buy back-in when it will be above 5% (earning 5% interest while out of the market). Under this scenario, the average return increases to 8.9% a year. This may not sound like a big increase, but it results in 25% more accumulated savings over the 40 years. However, the 8.9% p.a. assumes no transaction costs. Over the 40 years, the investor would have sold the shares on 14 occasions. Each time, they incur costs relating to brokerage and the market spread to sell and buy. Such costs are probably 1% to 1.5% on each occasion. Therefore, any return advantage would have been more than consumed by costs. The investor might have been better off financially long-term to stay invested, and not react to the market ups and the downs. 

The example is artificial in that the test was the return over the next 12 months being above or below 5% (the assumed alternative return) to determine whether to stay invested. However, it highlights the issues that even if you can get it right often, trading costs will consume a lot of any return advantage.

Conclusions

The past returns simply reinforce the observation that getting good returns from the sharemarket are more likely to be achieved if:

  • You stay in the market for the long term and this is more than 10 years.
  • You don’t try to actively pick when to enter or exit the market frequently. The returns of the individual years have a random look about them, so you are just as likely to pick a bad period as a good period.

You must also remember that when you might think it’s a good time to buy, there is someone else who thinks it’s a good time to sell.

Overall, we think that investors should not make decisions to invest in shares on the basis of recent returns. It is better to make these decisions based on goals, timeframe and the ability to tolerate the ups and downs of the markets. For most, the timeframe needs to be longer than ten years.

The legal stuff

The above article is a general investment commentary. It should not be considered as being personalised financial advice. Members should obtain appropriate financial advice from a suitably experienced Authorised Financial Adviser, before making any investment decisions. Only an Authorised Financial Adviser can legally take into account the person’s personal circumstances. SuperLife does not give personalised financial advice.