Stock Market Investing

Phil Hendry13/10/2020

What kind of returns could you achieve investing in the stock market?

This is something a lot of people want to know when considering investing.
And as you may expect, the answer is….it depends.
Depends on what?

Let’s take a look at the Credit Suisse Yearbook (which is a handy reference manual. It’s a summary of returns on lots of different markets in different parts of the world over the last 120 years).
You’ll see for example, long running returns in the financial markets *
This includes equities, which are a small slice of ownership (i.e. a share) in a company.
It also includes corporate and government bonds. Bonds are what the UK Government or big businesses such as Sainsburys might use to borrow money.
You loan them money.
They use your money to fund things such as surviving a pandemic or launching a new product or service.
They then pay back the loan (the bond) to you, with interest. Nice.

The Yearbook shows that over the last 120 years, equities have outperformed everything else, delivering on average a return of 9.6% p.a.
This is almost double the return rate for bonds (and way ahead of ordinary cash savings!).
So you would think then that you should put all your money in equities right?
Turns out there is more to it than that…

The Risk Factor

The returns you can get when investing in an asset are linked to how much risk is involved.
UK Government bonds for example, are deemed virtually risk free. This is because the UK Government is unlikely to default on paying you back.
They have also demonstrated in the past that they can print more money c/o the Bank of England to give back to you.
However, returns on these bonds are minimal because interest rates are so low.
At the other end, equities in developing countries could provide you with high returns. They can lose you just as much too. That’s because these countries can be less stable, and legal rights for foreign investors aren’t always very robust.

Experience has shown us that the following FOUR main factors are what you actually need to take into account when considering investing in stocks and shares.

stock market investing

Four Factors

Why are you investing in the first place?

What if just making as much money as possible isn’t your aim?
As we often find, more money is rarely what people are really investing for when pushed.
It may be to be able to work three rather than five days a week, buy a holiday home, pre-fund school fees…
We would encourage you to think about this clearly, because rather than chasing a bigger and bigger number which is ultimately rarely ever enough. Picture having a tangible object, event, or lifestyle which gives your money more meaning.

What do you need to make?

If you now understand why you are investing, you need to quantify this, for example, which mid-life crisis yacht it is you want to buy and the running costs. If you are clear on what is required money-wise, and you only need returns of 5% p.a., do you need to invest in equities and swallow more risk? Combining a diverse range of equities, with the right amount of lower risk vehicles like bonds, can get the returns needed, without as many of the ups and downs along the way.

When do you need it?

Normal everyday life. And what will happen in stock markets tomorrow. Next week or next month?
Impossible to predict.
But the farther into the future you go, the outcome becomes more reliable. This means the longer someone is invested, the impact of them investing at a very unfortunate time becomes much less of a problem. (Can you think of a recent event that triggered a market panic?!)
So when you need your money for that mid-life crisis yacht, and don’t expect to buy it for fifteen years, or even five years, you can afford to take more risk.
Because even if a significant event occurs, you’ll still have plenty time to recover and experience returns.
And if you are only investing for five years, you’ll want to ensure you take less risk and experience less potential market shocks.

How much can you afford to lose?

Lose or drop in value. The most extreme examples are those that have the vast majority of their wealth in one single thing or place.
Think of Jeff Bezos who has a majority in Amazon, Bill Gates in Microsoft or Elon Musk in Tesla. Putting all your eggs in one basket works the other way too- ask those unfortunate individuals who were heavily invested in the Royal Bank of Scotland around 2008. Yikes!

So if more money / optimal returns really is the only objective, that need for results pushes people to chase returns over a much shorter period (because we humans aren’t the most patient of creatures!). And to take excessively big bets in the process.

This is called Present Bias, where effectively we value our short term gratification over longer term objectives or our future selves. This is a more academic term for what most of us would know as ‘instant gratification’. We’ve mentioned investment biases before…

If this is the case, you should only invest this way with what you can afford to lose. Because with the possibility of maximum returns comes maximum losses. So by working through the first three points properly, you should know what your own amount is.

Before you hand over your hard-earned money…

Walk through each of these steps and make sure you understand what is involved of you.
You’ll want the greatest possible returns – same as anyone would – it seems like the only aim anyone should have when investing.
But there should be more to it than that!
This in turn will give you a better feel of what returns you could and should expect.

 

SOURCES
* Summary Edition Credit Suisse Global Investment Returns Yearbook 2021