THE STRONG ARGUMENT FOR EQUITIES
A decade of muted returns from equities has seen more and more investors avoiding or reducing exposure to equities as an asset class, preferring to invest in cash and near cash instruments only. As a response we have seen the rise of the “Income Fund” with many asset managers now offering an investment strategy that will only invest in cash and bonds. We argue that, although this strategy will be good for capital protection it will not deliver real growth and in this month’s Financial View, we explain why one should not avoid investing in the stock market.
The key outcome when investing is to always get back more than what you put in. Investors are thus emotionally wired to be negatively impacted by any downward price movements. We tend to associate risk with the chance of losing capital and investors need to be compensated for the risk that they take. This comes in the form of the higher possible returns that you should ultimately receive for investing in the riskier asset classes. Assessing the current investment trends, it would appear that investors, favour capital protection as opposed to generating higher returns as this is a secondary consideration (or perhaps not a consideration at all).
An avoidance of capital risk will however not guarantee the key requirement of getting out more than you invested as one needs to take inflation into account. The impact of inflation on your investment reduces your chance of achieving a successful retirement. Inflation is a very erosive force that decimates purchasing power. When we assess asset classes as potential investments, we look at the real return that we expect that asset class to deliver over a meaningful investment timeframe. The below graph compares the real value of equities (using the JSE All Share Index) and the real value of the Rand over a 30-year period after we have removed inflation from the respective series.
The graph has two axes with both series rebased to a starting value of 100. The gold line is the value of the Rand over time. The scale for this is on the right and what the graph tells is that the purchasing power of the Rand is now 18% of what it was 30 years ago. This makes sense to all of us as we know that rising prices are a fact of life. A loaf of bread costing R2 thirty years ago in 1992 (and could be paid for with just a single coin) would now cost R12 (and we would be using notes instead of coins).
For the investor to be in the position in which their investment has retained its value, they would need their investment’s value to have grown by 470% just to ensure that they have not lost any buying power/value.
The blue line represents the real value of the JSE All Share Index over the same 30-year period with its scale being on the left. Over the period the stock market has more than outperformed inflation. What is interesting though is that the outperformance isn’t delivered in a straight line. The stock market is volatile and there are periods of outperformance and periods of underperformance.
The reason that the stock market can protect against the erosive nature of inflation is that the listed companies that you are invested in are able to adjust their selling prices to counter inflation. For most companies if their input costs increase (such as salaries, electricity etc) they will adjust their selling price and pass these increases onto the customer. These increases eventually find their way to the consumer (you and me) and increase our cost of living. No other asset class offers this protection to the same ease. The longer your investment period the greater the benefit of inflation beating returns.
Focussing on the short term when investing often means that one can lose sight of the original investment goal – which is to generate wealth through getting back more than what you put in. We are really concerned that long term investors are not taking enough risk and are not adequately invested in growth assets like equities. By reducing risk and investing in cash type products, they will not meet their investment goals.
It would be a real pity if someone has done the basics right by making regular contributions to retirement savings over a long period of time, and still not meet their investment objectives through having exposure to asset classes such as cash that aren’t designed to outperform inflation.
We are aware that markets will correct every so often and that during your lifetime, you can expect about four or more large market corrections. During times like these it can be quite scary when you look at your investment statement, and it is often difficult to ignore the bad news. At these times, you would prefer to move to the safety of cash. This would however be the worst decision as you would lock in your losses and not be buying more units at a discount. When markets are down, it is often the best time for investors with a long-term horizon to be buying. The investor is buying assets at a discounted price and during these times the amount invested will produce the best long-term returns.
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