Anthony Hilton maintains that holding tight will pay dividends for investors who look past the peaks and troughs to focus on the horizon.
Albert Einstein got it about right when he said that compound interest is the eighth wonder of the world. Although portfolio management was not uppermost in his mind, he put his finger on a truth that is as absolutely fundamental when it comes to investing – worthwhile rewards come from having patience.
Barclays Capital produces an annual report analysing stock market performance going back to the start of the 20th century. One lesson to emerge strongly from the data is that when the growth of equities is measured on the assumption that all dividend income is reinvested, then shares have massively outperformed bonds in almost any period you care to choose.¹
However, using the same analysis purely on the basis of the capital growth delivered by equities – and taking no account of dividend income – then it is a much closer call, although equities still have the edge. You can infer from these figures that, in most decades, at least 80% of the long-term total return on equities comes from reinvested dividends.
Out of the blue
It follows that short-term share price fluctuations should not matter too much and we should try to ignore them, even if they can be quite startling, such as when Apple dropped 8% in a single day on reports of slowing iPhone sales². But we instinctively believe we will be better off trying to sell when we sense the market is about to fall and jumping back in when shares are on the rise again.
It is impossible to time the markets consistently. That has been particularly well illustrated in recent years and months, as markets today seem increasingly prone to sudden, violent movements – these movements often come out of a clear blue sky. It is not unknown for the gain of an entire year to be accounted for by just four or five really spectacular trading days. Be out of the market on one of those and you are unlikely to catch up.
Markets have always moved sharply as dealers mark prices up or down to encourage business in response to the daily news flow. But today the moves are more extreme and happen faster, because technology enables people to react instantly and to invest their money more quickly; plus, of course, there are banks of computers pre-programmed to trade automatically when they see unusual price movements. So the short-term noise can be quite deafening; so much so that fund management groups such as Legal & General³, and companies such as Unilever⁴, have turned against quarterly reporting, arguing that bi-annual reporting is quite enough.
Several years ago a team of behavioural economists at Barclays wrote a paper called Overcoming the Cost of Being Human.⁵ Among the points it discussed was the tendency for investors to frequently get shaken out of a stock if it falls in value shortly after they have bought it. They then sell in panic to avoid further loss.
Using the MSCI World Index, the Barclays analysis showed this was quite the wrong thing to do; over the past 40 years no matter when you bought and whether markets were high or low, you would have made money if you took (and held) a long-term view. In that 40-year span, the longest you had to hold on to show a profit was 11 years; but apart from a few freak periods where people were sucked in at market peaks, a holding period of between five and eight years was enough.
By the same token, it showed that the vast majority of investor losses were incurred on investments held for two years or less. The trouble is that we are programmed to react immediately to danger, and while we claim to be rational, in fact, emotion and experience play a huge part in our decision-making. We look for facts that confirm our prejudices rather than those that challenge our thinking.
We hate to acknowledge mistakes. We are frequently torn, and switch between security and performance. But at least if we recognise these weaknesses, we are halfway towards managing them, and more than halfway to a less angst-ridden investment life.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.