Quilter Cheviot: investment advice

Written by: Quilter Cheviot Posted: 07/03/2019

BL61_MichaelBullMichael Bull (pictured), Investment Director in Quilter Cheviot’s Jersey office, reassures investors by drawing on lessons learned from the often unpredictable markets of the past, and asks: what happens if you invest right before a market crash?

The end of 2018 was a difficult time for many investors, with some of the poorest short-term performance since 2015. As investors grew nervous over a combination of slowing growth, higher interest rates and increasing trade tensions, commentators warned about the dangers of a forthcoming recession. Many of our clients were understandably concerned, and contacted us to find out what was going on and whether they should adopt a more defensive investment stance. 

As it happens, we did not believe that the end of 2018 marked the end of the current good run in markets. While we were happy to reassure people, this option won’t always be open to us. We will have to face a market downturn at some point – that’s a natural part of investing. 

So how do we reassure clients – even if they are worried about investing right before a market crash? 

Investing without the luck

There are a number of ways to help answer this question. You can talk about the importance of having a long-term financial plan, reiterate the reasons for what we’re investing in, or explain the flexibility we have to help protect portfolios during a downturn in markets. 

The most powerful argument I can muster, however, is that the longer you invest for, the less relevant your entry point is. Seen from this perspective, it often makes sense to invest when you have a proper financial plan in place, rather than risk trying to time the market. 

Investing before the crash

To help show this, I looked at the last three bear markets in UK equities, examining what would have happened had you invested at the market high before the downturn. In our fictional example, we invest three lots of £100 in July 1998, January 2001 and May 2008. This is the only time we invest – right before the downturn. Our sole concession to reason is to reinvest the dividends we receive; otherwise we are just investing three lump sums of £100. 

The last three bear markets – those of the Asian financial crisis, the bursting of the dotcom bubble and the global financial crisis – saw declines of approximately 25%, 30% and 40% for UK equities. Any one of these would generate a fair amount of soul searching on any investor’s part – professional or otherwise. 

It’s worth bearing in mind that investing only at market highs is the exact opposite of what any investment manager, financial adviser or market pundit will tell you to do. In our example, we have the worst luck possible, and the investment strategy is one of the worst imaginable.

Despite this, our investments perform well over 20 years. By the end of December 2018, our £300 investment has turned into £650.53, more than doubling in value. Depending on which £100 lump sum investment you look at, that’s an annual growth rate of between 4% and 5.5%, although this does take into account any associated costs of investing. 

At that rate of return, you would have beaten cash, inflation, and government bonds, even with the worst luck possible.

It’s well worth repeating that we are intentionally picking the worst day to invest right before a crash. Your chance of picking the market high for UK equities in any one year is one in 212 – the number of working days in a year minus bank holidays. 

However, your odds of picking the worst day to invest two years running are about one in 50,000, with the chances of you doing that three times in a row vanishingly small.

If you are unfortunate enough to invest on the worst day ever three times in a row, you should probably sell your story to the financial press while prophesising the next bad day for markets. You would likely make up for any shortfall in returns. 

BL61AD_QC illoWhy do I do well even if I invest at the wrong time?

For many people, the result outlined above will seem counterintuitive. How can you still enjoy good returns if your starting point was so abysmal? 

The answer lies in the fact that equity markets generally return around 7% a year over the long term. If you invest before a downturn, you will inevitably see negative short-term returns, but these will gradually be erased by the continual 7% effect over the long term. The longer you invest for, the greater this effect will be. 

What about in the case of a really bad bear market?

Of course, many will still worry about what happens if we see an exceptionally aggressive bear market. What happens if we see another period like that of the 1930s, where the Great Depression caused US equities to fall by 89%?

The answer to this is complicated. First, and reassuringly or not, we have all already witnessed events which could have led to a second Great Depression – the financial crisis of 2008. It was precisely the lessons learnt from the 1930s that mean we are now in one of the longest bull markets in history, rather than talking about a second Great Depression. 

Second, our rule about investing for the long term still holds out. US equities delivered flat performance from 1929 to 1947, managing only to keep up with inflation, but the post-war period saw one of the greatest bull markets in history, with investors well rewarded for their patience. Between 1947 and 1965, US equities delivered an annualised return of 11% – more than half the rate we would typically expect equities to deliver. 

Keeping an eye on long-term opportunity

Hopefully, this will help to reassure anyone thinking about investing today. We cannot rule out the risk of a downturn, but we can say that a long-term investor will likely do well from the current point, provided they stay invested. There are ways that you can mitigate the impact of a recession, but when looking at my own portfolio, I find the idea of a long-term time horizon to be most comforting. After all, it’s something I can control. 

For those who believe that markets are expensive currently, and are waiting to invest at the bottom, ask yourself whether you will really be prepared to buy back in when the news is more negative. You could have looked at equities in the depths of the financial crisis, seen that they were objectively cheap and bought in. But you would have had to contend with worries about the collapse of the global financial system, a return to tariffs and protectionism and, had you been particularly prescient, concerns about the disintegration of the euro. Good luck investing at the bottom with that on your mind!

Buying at the bottom is never easy, and there’s always a reason to hang on for that last leg down. As a species, we are inherently risk averse, feeling the pain of losses twice as much as the joy from gains. That probably served us well in the past, but investing requires a slightly different approach.

Making sure that you are a long-term investor who’s able to ride out all the ups and downs of the market is the best approach to take, even if you do prove to be exceptionally unlucky. 

For further information, please visit www.quiltercheviot.com or contact: 
Tel: +44 1534 506 070
Fax: +44 1534 768 108
Email: michael.bull@quiltercheviot.com

• This is an advertising feature that was first published in the March/April edition of Businesslife magazine

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