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Coronavirus

Why Owning a Broadly Diversified Portfolio Makes Perfect Sense

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At times like this when there is great uncertainty, wouldn’t it be great if we had the means to look into the future? Perhaps not some might argue. Unfortunately, we don’t know the future – no one does.

When it comes to investing, it can be tempting to run ‘what if’ scenarios in our heads, such as ‘perhaps I should move into technology and pharmaceutical companies – as surely these will do well’ or to pick out specific companies that appear likely to thrive in the future.

However, two challenges exist.  The first is that you won’t be the first person to have thought this and the combined views are already reflected in market prices. The second is that in making such focused bets you have a high chance of being wrong and missing out on the companies that actually end up driving future returns. Remember, 30 years ago Amazon and Google did not exist.

To get a feel for what these focused risks look like, academics are able to explore a vast amount of equity market data in the US, known as the Centre for Research in Security Prices (CRSP) database.

One such study[1] reveals some surprising and useful findings between 1926 and 2015.  Whilst investment wisdom and empirical evidence support the case that equities, in aggregate, outperform cash over longer periods of time, a closer look at individual equity returns tells a very different story. Here are some of the insights that the paper provides:

The median time that an equity/share is listed on the CRSP database is only seven years, during the period 1926 to 2015. That’s not long.

Just over 40% of all equities/shares have a holding period return that exceeds the return of cash (in this case one-month US Treasury bills) over the period that the equity/share was in the database. More than 50% deliver returns that are negative. The median lifetime return on any single equity/share was -3.7% p.a. That’s not good.

26,000 equities/shares have appeared in the CRSP database since 1926, yet only 36 survived the entire 90-year period. That’s not many.

US $32 trillion of wealth was created between 1926 and 2015, which has been generated entirely by the top 1,000 companies, representing less than 4% of the total number of companies listed over time. The top thirty companies (0.1% of all companies) accounted for around 30% of the total stock market’s wealth creation. That’s pretty concentrated.

This is why, at times like this, and in fact across all time periods, we believe it makes enormous sense to remain highly diversified, so as not to miss out on the next Exxon (the firm that has added most value to the US market ever), Apple or Amazon.

Now, let’s look at how the top ten US firms by revenue changed between 2000 and 2010 and again between, 2010 and 2020.  The results are so revealing.  Just look at the new companies making it into the top 10 in 2010 and then in 2020.  Look at the names which disappeared from the top 10 in 2010 and again in 2020.

Top 10 US companies by revenue over time (2000, 2010, 2020)

Source: Fortune 500

Correctly picking which few companies are going to be driving market returns over the next decade or two will not be easy, or likely. Even if you could, remember the majority of us are investing for more than 20 years.

At Wells Gibson, we believe it makes perfect sense to own the top companies by owning a broadly diversified portfolio which invests in thousands of companies.  Missing out on these companies, perhaps that don’t even yet exist, could make all the difference between a good investment outcome and a very poor one.

Please keep safe and don’t hesitate to get in contact if you have any questions.

[1] Bessembinder, H., (2017) Do Stocks Outperform Treasury Bills? WP Carey School of Business, Arizona State University.
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Sitting Out an Equity Market Fall

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For many of our clients, the purpose of accumulating wealth in a portfolio is to provide a sustainable income either now or in the future that is, at the very least, able to cover their basic needs and hopefully a bit more.

The level of portfolio-derived income required is unique to each client.  Some of our clients have pensions from final salary schemes and possibly other income from other sources, such as property.  Other clients need to rely more fully on their portfolios.

Portfolio income comes from the natural yield that a portfolio throws off in the form of dividends from companies and coupons (interest payments) from bonds, and capital makes up any shortfall.  When markets rise, as they have done most years since the Global Financial Crisis a decade ago, portfolios may even grow after an income has been taken, although this will not always be the case.  When markets fall, it can begin to feel a little uncomfortable as dividends may be cut and equity / share values may be down materially, as we have seen in the first quarter of 2020 (albeit, the upturn in April has helped).

The cardinal investment sin at these times is to sell equities when they are down and turn falls into losses.  To avoid doing this, income required above a portfolio’s natural yield can be taken from bonds or cash reserves.

You first question might be, ‘How long might I have to do this for?’. 

The figure below, helps to answer this question.  It uses a range of regional (Europe, Asia-Pacific ex-Japan, Emerging and World) and major individual equity markets (US, UK, Japan) and plots the top 10 largest market falls for each and the time taken to recover back to the previous high, in, before-inflation terms[1].

Some overlaps obviously occur (e.g. the US is a material part of the World), but broad insights can be gleaned: most market falls recover within 5-6 years, some may take a up to a decade or so, and outliers can and do occur, such as Japan which took 27 years to recover (in GBP terms) from its market high in 1989.

Figure 1: How long will we have to wait?

Data source: Morningstar Direct © All rights reserved.

What is also evident is that, with the exception of Japan, these market falls all sat well within most investors’ true investment horizons.  Whilst Japan provides a helpful lesson that investing outcomes are uncertain, widely diversified portfolios do help to mitigate country-specific risks.  Even investors in their 80s should be planning to live to at least 100, giving them a 20-year investment horizon (today an 80-year-old woman has a 1-in-10 chance of reaching 98[2]).

The question of how much cash or bonds an investor should hold will vary depending on how important it is for them to meet their basic income needs and how important it is having more discretionary spending[3].  Using a sensible multiple of basic annual spending, and possibly additional discretionary spending, is a sensible starting point from which to reach a suitable minimum.  For those to whom certainty of income is critical this could be significantly higher and for those to whom it is less critical, it might be lower.  For all investors, it should be sufficient to ensure that they can sit out any market fall relatively comfortably, without having to sell their equities.

Sitting out an equity market fall is not so bad, when you know how long the wait might be and you come well prepared to sit it out.

As always please get in contact if you have any questions.

[1] MSCI World NR, IA SBBI US Large Stock TR, MSCI United Kingdom NR from Jan-72; MSCI Japan NR, MSCI Emerging Market GR, MSCI Europe NR, MSCI AC Asia Ex Japan GR from Jan-1988.
[2] https://www.ons.gov.uk/
[3] It will also depend on other factors such as their need to take risk, their risk profile, and their financial capacity for loss, all of which should be discussed in detail as part of the ongoing financial planning process.
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Financial Guides for the Employed, Self-Employed and Small Businesses

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Wells Gibson is delighted to announce that the global community of financial planning, in conjunction with the Chartered Institute for Securities and Investment (CISI),  has produced two financial guides, one for the employed and one for the self-employed and small businesses.

These short, easy to read, financial guides are designed to help you think about your finances by highlighting the important factors and steps that leading Certified Financial PlannersTM professionals recommend you should look at during this uncertain and challenging time.

We hope you find the guides useful and as a CFP professional, our very own Jonathan Gibson is ready to help you manage your finances and look to the future.

Should you have any questions at all, please don’t hesitate to get in contact with Wells Gibson.

Financial Guidance for the Employed

Financial Guidance for the Self-Employed and Small Businesses

Billions Wiped Back onto Pensions

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This was not a news headline, nor will it be a headline we will ever see.

Yet this is exactly what happened on Tuesday this week.  The FTSE100 had its biggest rise ever, and the Dow Jones in the US went up by more than 11%, the biggest daily gain since 1933.

Our news doesn’t report this.  Good news doesn’t sell, sadly.  Sensationalist, bad news is what we hear when billions are wiped off the value of our pensions.  No big deal apparently when billions are added to our pensions.

Are we out of the woods?  We don’t know – it seems unlikely, as the economies of the western world have shut shop for three weeks, minimum.  We would be surprised if we don’t see further volatility in the days and weeks ahead, but who knows?

Tuesday’s rises demonstrate one thing very clearly, that is, when markets move, they often move very fast, and very unexpectedly.  Trying to time it is very difficult; we would say it is impossible, without a lot of luck.  It’s why we stress to all our clients that it’s time in the markets, not timing the markets that matters.

Many people have been asking, are markets at their lowest, have they bottomed out?  Who can say? The truth is, no one knows with 100% certainty.

What is absolutely certain is that shares in the great companies of the world are available for purchase at a significant discount from six weeks ago.  Also, it’s worth highlighting, with a high degree of confidence (although not certainty), that the price of shares in the great companies of the world will be higher in five years than they are now.  That’s all that matters; all else is noise and distraction.

One last point, knowing how the news reports on capital markets does make me wonder how good or bad things really are when it comes to other world events.  Perhaps, worthwhile, switching off the news!

As ever, please do get in contact if you need our help.  Our great team will do its best to help us all get through this together.

Please note that past performance is not a guide to the future, the value of an investment and the income from it could go down as well as up. You may not get back what you invest.

 

Today’s Market Falls in the Context of History

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It’s been another tough week for capital markets however, context is an extremely important tool when it comes to investing.

All investors around the world will be feeling the emotional pressures of the recent rapid equity market falls, either because they can remember previous falls and times of uncertainty, such as the Global Financial Crisis (2007-2009), or as younger investors, they have not yet experienced material market falls.

We obviously cannot see into the future, however the global equity market falls we have seen since January, of under 20% or so at the time of writing, sit well within previous falls since 1970.

In terms of expected ranges of outcomes, we generally estimate that 95% of the time annual equity market returns should sit within an approximate range of + 45% to – 35% albeit outliers do exist beyond these limits.

The table below provides numbers around both the depth and recovery times for each of the five largest falls since 1970.

Peak date Decline Trough date Recovery date Decline

(months)

Recovery (months)
Sep-00 -49% Jan-03 Dec-10 29 95
Jan-73 -40% Sep-74 Jan-76 21 16
Jan-90 -35% Sep-90 Jan-93 9 28
Sep-87 -29% Nov-87 Mar-89 3 16
Jan-70 -19% Jun-70 Jan-71 6 7
Jan-20 -19%

How deep or long the current fall will be, no-one knows.

There will certainly be more rises and falls to come.  Yet we should take some comfort from the fact that things have been just as challenging at times in the past, albeit for very different reasons.  Recovery times sit well within the investment timeframes of most investors.  It is worth noting that an investor in global equites today has, in nominal terms, more money than they did at the end of April 2018, despite the market falls in late 2018 and those recently experienced.

These are tough times for all of us and for our Nation, but the words of wisdom that we always return to at these times are those of the legendary investor John Bogle, “This too will pass.”

This will pass and from an investment perspective, the key message is to be brave and disciplined as a fall only becomes a loss if we sell.

Remember, we are always available to take your call or answer your emails.  Please feel free to contact Wells Gibson, if you have any specific questions or simply if you would like some reassurance.

Photo by Jerry Zhang on Unsplash