FINANCIAL MATTERS WITH MITCH HOPKINSON: The pros and cons of investing in the stock market

Mitch, a recipient of the ‘Financial Times Independent Financial Adviser of the Year Award’, is Head of East Midlands at deVere United Kingdom, the UK division of deVere Group, one of the world’s largest independent financial advisory organisations

Should you invest in the stock market?

If you keep all of your money in a bank or building society, so long as it is below £85,000 your money is very safe, but with interest rates so low, and inflation running at 1.8 per cent, you will probably lose money over the long term as historically the rates in bank accounts barely keep pace with inflation.

I was looking at inflation rates the other day and I was surprised to find that the average rate of inflation from 1948 to 2013 was 5.5 per cent.  Would you believe that the highest annual rate was 24.9 per cent?

With this in mind, I thought I would spend some time looking at why it is important to consider where your money is invested, particularly when you are saving for the long term such as retirement.

Next month I will look at the new pension changes and how these will affect your decisions when it comes to retirement.  This month will help put matters in perspective as we look at investments and the case for investing in the stock market.  

Investing in shares is an important aspect for most people who would like to obtain the best long-term returns on their investments and pensions.  

But research shows that for many people, the long-term has to be very long-term indeed to guarantee that an investor doesn’t lose money.  

Unfortunate timing can mean it can take several decades for markets to make up for a period of losses.   

Analysing data going back to 1900 shows that there was a period as long as 17 years when investing in American shares showed zero real returns, even with dividends re-invested. There were three periods of negative real returns: 1905-20, 1906-21 and 1966-88.

So the past few weeks of the stock markets around the world posting losses will make people think again about investing in equities. As it should, since investing in equities is risky over the short term, but over the long term the case for having  part of your investment portfolio, especially your pension allocated to the stock market is difficult to argue against.

It is really important now more than ever to review your investment objectives as the return that you receive for leaving money in a bank account is really low. In fact it is dreadful. In order to get any sort of return on your money, you really need to invest in a term based deposit so as to get a better rate. On 5th March 2009 the Bank of England halved base rate, from one per cent to 0.5 per cent. The base rate had already been on a precipitous decline, having been 5.0 per cent in October of the previous year. The move in March 2009 was an emergency measure at the height of the financial crisis: nobody was expecting that half a decade or so later base rate would still be at 0.5 per cent.

Remember if you deposit all of your money in a savings account, historically it would grow at a steady rate, determined by the interest rate paid by your bank or building society.

However, the returns on stock market based investments are not guaranteed and the value of your money will rise and fall in line with the performance of the companies you’re invested in.  If you are only looking to invest for a short period of time then the stock market is not for you as it is entirely possible that you will lose money, but over longer periods history has repeatedly shown that equities grow faster than cash. If you were to plot your returns over 10 years on a graph you would see peaks, where the value of your investments is rising, and troughs where it is falling. But over time it is likely that there will be more ups than downs, and at the end of that decade you will have both more than you originally invested and more than you would have had if you had left your money in a savings account.

Barclays for example has conducted extensive research comparing real returns on cash, that is with inflation taken into account, and equities stretching from the end of 1899 to the end of 2012.

The findings illustrate both the likelihood of equities beating cash and the benefits of holding investments for the long term. Over two years, the shortest period analysed, the research said there is a 67 per cent chance that equities could perform better than cash. With a 33 per cent probability that cash will fare better, this still could be a sizeable risk for more cautious investors, particularly with interest rates so low at the moment.

In fact the case for a rise in interest rates seems to be more likely next year in late summer, than at all this year.

But as the holding period grows, so do the chances of equities beating cash. You can see that over five years there is a 75 per cent probability that equities will outperform cash, to 90 per cent over 10 years. If you can invest for 18 years there is a 99 per cent chance equities will beat cash.

The Barclays Equity Gilt Study is one of the most frequently quoted sources of long term stock market performance. Barclays’ data on UK investment performance goes back to 1899, giving it a perspective few can match.

One surprising aspect of these numbers is that over the last 10 years, to quote Barclays ‘Cash … delivered the worst returns since the stagflationary 1970s’. While inflation was memorably high in the 1970s and early 1980s, 1975 saw annual inflation of 24.9 per cent, interest rates were also at peak levels.

Then the base rate reached 17 per cent 1979.

In the last 10 years inflation has been largely under control, if not within the Bank of England’s target, but the last five years of 0.5 per cent base rates have hit post-inflation returns. 

What should we conclude from this?

I think it is clear that over the long term you must consider carefully how you invest.  For those people who still worry about the risk of losing money and cannot cope with the possibility of their investments going down in value, there are a number of investments that protect your capital fully and give the prospect of better returns.  These deposit based capital protected bonds are a really good way of boosting returns.

As always, if you are not sure, consult with a good independent financial adviser.

Mitch Hopkinson is a managing partner of deVere United Kingdom, part of the deVere Group, one of the world’s largest independent advisers of specialist global financial solutions to international, local mass affluent, and high-net-worth clients, through a network of 70 offices across the world and more than 1,000 staff. It has in excess of 80,000 clients and $10bn under advisement.