Back to Basics: Investing is a long term game

Believing that ‘now’ is the most difficult point in history to make sense of markets is one of the biases which investment professionals can pick up from their extreme proximity to the volatility, uncertainty and surprise that go with investing money. The cure to these jitters is just to step back and review some of the fundamentals.

“Everything that needs to be said – has been said. But since no-one was listening, everything must be said again.” André Gide.

Believing that ‘now’ is the most difficult point in history to make sense of markets is one of the biases which investment professionals can pick up from their extreme proximity to the volatility, uncertainty and surprise that go with investing money. Has it ever been easier to fall into this state of mind?

Equity markets are holding up against the expectation of interest rate rises after 8 years of ultra-low rates, with asset prices pegged in place by public credit after private credit managed so spectacularly to destroy itself in 2008? Has there ever been a more unpredictable, capricious US President facing off a tyrant armed with nuclear weapons? At home, should we be concerned that Brexit, the most complex negotiation ever attempted in peacetime, will be upset by challenges for the leadership of the Conservative Party? While a new French leader looks to capitalise on a chance for strategic economic gain to the disadvantage of our capital city.

The cure to these jitters is just to step back and review some of the fundamentals.

Investing and Saving

Before the Credit Crunch, it was easier to draw one of the key distinctions in wealth management, that between saving and investing – because you were paid a reasonable amount of interest for putting your money on deposit.

In July 2007, Mervyn King raised rates to 5.75%. That summer the average Building Society account was paying 5.15%. When interest rates were cut to zero by government policy, ‘natural savers’ were put in a dreadful situation. They faced a choice between either a certain erosion of their purchasing power (getting no interest paid to compensate them for inflation) or having to take some form of market risk to make any return at all.

UK Historic Interest Rate

UK Historic Interest RateSource: Bank of England, 2017

The rise in equity income funds and the credence given to risk profiling tools over recent years is telling in this context.

Investing and Speculation

Just as important a distinction is the one between investing and speculation – where speculation is defined as heavy commitment of capital to situations promising very high returns, often over the short term.

The appeal of speculation is obvious, at least to some. It promises high excitement and high profit. The prospect of loss, if it is not simply disregarded outright, can even act as a source of encouragement, heightening the excitement.

Bitcoin and crypto-currency are the latest fads for very high-risk takers

What investment is all about is diversifying portfolio risk to minimise the prospect of loss and maximise the return for the level of risk accepted. One can make this point without fear of contradiction by stating that whereas many speculators have gone broke, no-one with a 50/50 mixed portfolio of UK Government bonds and UK equities has ever lost all their money in the markets. Equally no saver has ever made an annualised return of over 9% a year for five years as mid-risk Parmenion portfolios have returned since 2012.

Two key points: Diversification and holding period

The reasons that investing works for retail clients are twofold. The first is professional portfolio construction and the second is time.

A carefully considered asset allocation, with broad diversification between markets, and careful due diligence of investment funds will deliver a return in line with expectations based on historic norms, given a reasonable holding period. At Parmenion we would expect this to be over five years. If that is too long for a particular client, at a middling risk grade, they are probably a ‘natural saver’. It’s a fact that for some, equity volatility is too much to bear. Happily for them our Risk Grades 1 and 2 may get close to doing the job historically performed so well by a deposit or building society account.

If these returns look unattractively low and the investor can’t commit to keeping their capital undisturbed in the market, they may be a ‘natural speculator’. Bitcoin and crypto-currency are the latest fads for very high-risk takers.  But that’s not something Parmenion plan to offer as we are not in the speculation game.

 


The above article was first published by Parmenion on 19th September 2017