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Stockmarket

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.
Photo by Colin Horn on Unsplash

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

Top Tips for Staying Calm in Today’s Markets

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At times like this, it is sometimes worth reminding ourselves that it is this very uncertainty of shorter-term market outcomes that delivers investors with returns above those of placing bank deposits.

 

This allows us to grow our purchasing power over time.  In the case of equities / shares, this uncertainty can be high as the market adjusts its view of long-term earnings and the discount rate it uses to establish market prices.  If there was no uncertainty, then there would be no equity premium.

 

In contrast to the recent sensationalist headlines, such as the BBC’s ‘Coronavirus fears wipe £200 billion off UK firm’s value’, the never-published headline of, ‘Over the past 10 years global equity markets have turned £100 into £266, so giving a bit back is perhaps to be expected’ provides some comfort to those already invested.

 

To those who aren’t invested or have money to invest, equities / shares are cheaper than they were at the start of the year.  Good news does not sell as well as bad news!

 

You may be asking yourself whether this health-driven market event is different to those that have gone before.  It is, but only because every market fall is driven by a different combination of events that impact on future corporate earnings.  What should remain the same is our response to it; avoid panic, avoid unnecessary emotionally driven investment activity, believe in your portfolio and the power of markets and capitalism to recover in time.

 

Here are some tips for clients of Wells Gibson, to help keep things in perspective: 10 things to remember during a market fall.

 

  1. Embrace the uncertainty of markets – that’s what delivers us strong, long-term returns. Remember that you own lower-risk, defensive bonds in your portfolio too.  Your portfolio won’t have fallen in value as much as the headlines.

 

  1. Don’t measure your portfolio’s performance from the top of the market, but over a longer and more sensible timeframe. Over the past five years, investors have received handsome growth.  Even over the past year, equities are only a little below where they started.

 

  1. Don’t look at your portfolio too often. Get on with more important things.  Once a year is more than enough.  If you are looking every day, don’t.  Stop listening to the news too, if it concerns you.

 

  1. Accept that you cannot time when to be in and out of markets – it is simply not possible. Resign yourself to the fact.  Hindsight prophecies – ‘I knew the market was going to crash’ – are not allowed.

 

  1. If markets have fallen, remember that you still own everything you did before (the same number of shares in the same companies, and the same bonds holdings).

 

  1. Most crucially, a fall does not turn into a loss unless you sell your investments at the wrong time. If you don’t need the money, why would you sell?  Falls in the markets and recoveries to previous highs are likely to sit well inside your long-term investment horizon i.e. when you need your money.

 

  1. The balance between your growth (equity / share) assets and defensive (high quality bond) assets was established by Wells Gibson to make sure that you can withstand temporary falls in the value of your portfolio, both emotionally and financially. If necessary, we can rebalance your portfolio to make sure that you have the right level of equities to benefit from future market rises.

 

  1. Be confident that your (boring) defensive assets will come into their own, protecting your portfolio from some of equity market falls. Be confident that you have many investment eggs held in different baskets.

 

  1. If you are taking an income from your portfolio, remember that if equities have fallen in value, you will be taking a lot of your income from your bonds and not all from equities when they are down.

 

  1. Wells Gibson is here – at any time – to talk to you. We will urge you to stay the course and hopefully be a source of fortitude, patience and discipline.  In all likelihood we will advise you to sell bonds and buy equities, just when you feel like doing just the opposite.

 

 

State pension age equalisation is here

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State pension age equalisation has taken place in the UK.

The gradual change now means that women qualify for their state pension from age 65, the same age as men.

State pension equalisation has taken a long time, 25 years in fact.  During that time, the age rise for women was gradually phased in, with women celebrating their 65th birthday on 6th November 2018 the first to qualify for a state pension at the same age as men.   Despite equal ages for state pensions, equality of retirement income remains a long way off.  Maike Currie, Investment Director at Fidelity International said:

“The pension system is relatively equal if people follow the same working pattern from age 20 to retirement, but they don’t.  Women are more likely to have fragmented careers, be self-employed or work flexibly during their working life as they continue to bear the brunt of the childcare or take a career break to care for sick or elderly relatives.

“Of course, these factors are increasingly affecting men too, however, the average women’s pension pot is already much lower than the average man’s so women need to have the ability to catch up. As the Cridland report pointed out, in the first year of retirement women are expected to have 25% less income than their male counterparts.”

The final report from the Cridland Review was published last year and made a number of recommendations in respect of the state pension.  Report author John Cridland, a business executive, proposed an accelerated increase in the state pension age.  It is already due to rise to age 68 between 2044 and 2046, having an impact on those born after 5th April 1977.  Cridland wants to see the state pension age rise to 68 between 2037 and 2039, bringing this increase forward by seven years.  As a result, anyone born after 5thApril 1970 would have a higher state pension age.

Further rises in the state pension age seem unavoidable in light of improving life expectancy.  Without a higher state pension age, people living for longer would make the state pension unaffordable for the taxpayer.

The Cridland Review also recommended abolishing the ‘triple lock’ for increasing state pension payments each year.  This currently gives state pensioners a degree of protection from price inflation, with their state pension income rising each year in line with the greater of average earnings, price inflation or 2.5%. Instead of having this triple lock in place, John Cridland proposed that state pensions in the future rise in line with average earnings.

One group who are unhappy with the equalisation of state pension ages for men and women are 1950s born women represented by the Women Against State Pension Age Inequality (WASPI) campaign group.  They are arguing for government compensation after claiming to be unaware their state pension age would rise, as the government did not routinely write to women to let them know about the change.

Your state pension is likely to form an important part of your total income in retirement.  It’s important to understand when you will start to receive a state pension income and how much this is likely to be.  A good place to start is requesting a free state pension forecast at gov.uk/check-state-pension and then speaking to your financial planner to incorporate these figures within your overall plan for retirement income.

Why market timing is futile and it’s time in the market that counts

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There’s a lot for investors to worry about.  High market valuations, rising interest rates, the prospect of a no-deal Brexit and escalating trade tensions fuelled by Donald Trump, all raise the likelihood of greater market volatility.

When markets are more volatile and investor sentiment turns negative, resulting in short-term falls in value, it can be tempting to try and time the markets.  Timing the markets involves attempting to sell before equity markets hit the bottom and then buying before they start to rise.  This sounds good in theory but, in practice, it doesn’t usually work out that way.  Instead, investors can find themselves selling low and buying high!  If investors repeat this process enough times they will soon run out of money to invest.  At the very least, the value of their portfolios will take a big hit.

One of the biggest problems with attempting to time the market is that you can easily miss out on a few of the best days of returns.  Do this, and your overall long-term returns will be significantly worse.  According to a study from Fidelity International a couple of years ago, an investor who invested £1,000 in the FTSE All-Share index 30 years ago, but missed the best 10 days in the market, would have achieved an annualised return of 7.09% and ended up with a total investment of £7,811.55.  This compares with an annualised return of 9.38% and an investment worth £14,733.64 if they had stayed in the market the whole time – an opportunity loss of £6,922.09.  If an investor had missed the best 20 days, their annualised return would be 5.55%, which would have resulted in an even worse shortfall of £9,676.56.

This research should remind us that volatility is the price we pay as investors, for long-term outperformance from equities, relative to other investment asset classes.  The potential for long-term returns comes from risk in the form of market volatility.

There are significant risks associated with trying to time the markets.  This is because it is so difficult to predict the best time to get out and then get back in to equity markets, during periods of market volatility.  These risks are magnified by the impact of the very best and worst days of market performance tending to be grouped together during periods of increased market volatility.

A more sensible approach to investing is to keep your money exposed to the markets throughout the entire market cycle, during the ups and the downs.  There’s an old stock market adage which says time in the market matters more than timing the market.  At Wells Gibson, we would tend to agree.

When markets are especially volatile, the value we add as financial planners, is to guide our clients and keep them focused on their long-term, lifestyle, financial and investment objectives.  Furthermore, because we can demonstrate the value of time in the market, and the futility of market timing, we are able to secure the best long-term results for our clients.

If you have been tempted to try market timing in the past or perhaps, during the current bout of market volatility, why not give us a call and see if we can keep you on the right track.