FREE KIC - NO. 11 AUGUST 06
I CRAZY INVESTING MY SAVINGS IN SHARES?
Last month I wrote about a number of people I know that
not putting money into a pension. Not only do these people not put
money into a pension but they also tend to think that the stock market
is too risky and that it is no different to gambling on a horse. They
think I am mad to put most of my savings in the stock market. Many of
them tend to have been burnt by investing in Eircom and this has left
them scared of all shares. Even friends that do have some exposure to
the stock market through employee schemes ownership schemes or through
investing in a tip they have received from somebody else will express
the view that the stock market is incredibly dangerous and not a place
to put much money.
I then tend to give my little speech about the long term historical
performance of equities. I tell them that history is on my side because
in the long term a diversified portfolio of shares has always given a
real return that justifies taking the risk. I do not tend to go into
the detail and I certainly do not go down the road of giving an
academic argument based on the equity risk premium. Now and again I
might mention that I have met the executives of hundreds of companies
and the vast majority of them attempt to generate profits greater than
the risk free rate. I think that a number of people I have mentioned
this to do not see the connection between the way the company is run
and the share price. Everyone understands that Eircom was out to make a
profit, sure isn’t Eircom robbing everyone blind! Yet this
not guarantee that people made a profit by investing in it. I cannot
even argue that in the long run people will make their money back
because they all got bought out at a loss. Even those people that still
have their Vodafone shares will never make a decent return.
Having listened to so many people express the view that investing in
the stock market is not for them has made me think long and hard about
this idea of an equity risk premium. Is it really that easy? Can I
genuinely say to people that all you have to do is buy an index fund or
an index ETF (Exchange traded fund) and if you hold on to it for 10 to
20 years you will definitely do better than leaving the money on
deposit? I realise that I cannot make the argument about any individual
share because there are any number of reasons why one company will not
perform. But can I genuinely make the argument that investing in a
sufficiently diversified basket of shares that diversifies away stock
specific risk will capture this magical thing known as the equity risk
If it is genuinely that easy why isn’t everyone doing it?
every professional investor knows enough about history to know that
equities outperform. Put your money into the market sit back and wait
for the good times to roll. Just ignore those blips that are caused by
inflation, oil, politics, terrorism, valuation bubbles, dodgy
accounting, under funded pensions, strikes, greedy executives etc, etc.
Can I really say to people that the next time they hear George Lee on
the RTE news say “billions wiped off the stock
they should just switch channels secure in the knowledge that the day
billions are added to the stock market it will not make headlines on
the RTE news.
Having had all these doubts and having asked all these questions about
whether it really is that easy maybe I have hit the nail on the head
because the reality is that nobody and I mean nobody I know finds it
easy to ignore all the blips.
Lets look at it from a professional investor perspective. A few years
into my investment career I remember one investment director made the
case that equities outperform in the long run and therefore he decided
to increase the exposure of long term funds like pension funds to
equities. He gave presentations to clients supporting this position and
then he sat back waiting for the good times to come along. Now of
course he wasn’t to know that Iraq was just about to invade
Kuwait. He wasn’t to know that the price of oil was going to
increase dramatically. I don’t know if many people can
back to that period and remember just how much fear there was of the
Iraqi army. There was a genuine fear of a long lasting war that could
destroy oil fields in Iraq, Kuwait, Saudi Arabia and possibly further
down the Persian Gulf. The investment director still thought that in
the long run equities would perform but he began to panic that on a one
or two year view they would
perform and in the world of professional investment you generally get
fired if you under perform for three years. In the circumstances we
panicked and reduced our exposure to equities. In hindsight it looked
stupid because as we all know the Gulf war ended quickly and the price
of oil fell back. Naturally enough a short while later the exposure to
equities was increased again but the damage had been done.
Later on in my career another investment director made the same
argument that shares were the place to be. After the stock market
bubble collapsed in 2000 he began to have doubts. He held out until
2002. You can imagine my surprise when I came back from the world cup
in Japan in June 2002 to discover that we had reduced our exposure to
shares. The stock market hit bottom in 2003 and later on equity
exposure was increased again.
I heard a similar story from a former colleague who worked in Swiss Re.
They managed to sell at the very bottom in 2003.
Having seen how difficult it is for professional investors to ignore
the blips makes me understand why it is that the equity risk premium
appears to exist. If the professionals cannot take advantage of the
long run what chance have the amateurs.
Only time will tell whether my analysis is right but it is my intention
to invest through the blips and try to take advantage of this equity
risk premium. I hope my clients will live with me through the ups and
downs and we will all make money in the end. Watch this space.
< Previous opinion piece
| Return to index | Next opinion piece >