In the long run, it’s difficult to find a better investment than equities, but as Keynes famously said, in the long run we are all dead. How long, then, do investors need to hold on to equities to be assured of decent returns?
The latest Barclays Equity Gilt Study, which contains a mountain of data pertaining to long-term asset returns in the UK and US, shows that the past decade has been a relatively disappointing one for equity investors. Adjusted for inflation, British stocks have averaged annualised returns of just 2.3 per cent over the past decade. Risk-averse investors have actually enjoyed better returns, with gilts (UK government bonds) returning annualised returns of 3 per cent since 2005.
Although US stocks have tripled in value since the global financial crisis reached its nadir in March 2009, the past decade has been a similarly uninspiring one for American equity investors. Real returns have averaged 4.9 per cent, which is not to be sniffed at, although it is well below the average performance since 1925 of 6.6 per cent. Indeed, equities have only barely outpaced US government bonds, which have returned 4.6 per cent annually over the same time frame.
Anyone who was fully invested during the global financial crisis, however, won’t be complaining about recent returns, given how stark their situation must have appeared at that time. When Barclays’ annual Equity Gilt Study was published in 2009, investors had just suffered a lost decade: people who had invested in US equities at the end of 1998 had lost money, while British stocks had lagged behind inflation. Those memories are fresh in the minds of investors, but it’s worth remembering that the noughties was an extremely atypical decade for investors. Barclays’ 2009 study noted that US investors had just suffered the fourth-worst 10-year return of the past 83 years, having endured a decade unseen since the 1930s. In the UK, it was the second-worst 10-year period over the previous 109 years.
Holding periods
Barclays’ 2016 edition makes clear that the longer you hold on to equities, the greater your odds of making money. British equities have outperformed cash over 68 per cent of all two-year periods over the past 115 years (put another way, if you invest in stocks but plan on withdrawing your money within two years, you have a one-in-three chance that you would be better off putting your money in an old-fashioned deposit account).
If you invest in equities for five years, your odds of success improve to 75 per cent. Extend the holding period out to 10 years improves it to 91 per cent. The prospect of losses grows more minuscule after that; anyone with UK stocks for 18 years has beaten cash 99 per cent of the time.
Barclays does not compare US returns against cash, although separate data confirms financial losses become ever more unlikely if you extend your holding period. Historically, stocks have fallen on 46 per cent of days, in 32 per cent of three-month periods, in 26 per cent of one-year periods, 14 per cent of five-year periods and just 6 per cent of 10-year periods. US stocks have never declined over a 20-year period.
Equity investors
Bond investors have a better chance of outperforming, but odds still favour equity investors. UK stocks, according to Barclays data, have outperformed gilts in 68 per cent of one-year periods, 72 per cent of five-year periods, 79 per cent of 10-year periods, and 86 per cent of 18-year periods.
Long-term investors will not do nearly as well, however, if they choose to spend their dividends rather than reinvest them. Adjusted for inflation, £100 invested in the UK stock market in 1899 would be worth £28,232 today. If dividend income was not reinvested, however, then real returns fall to just £177. The effect upon bond portfolios is not quite as dramatic, but it too provides a valuable lesson in the power of compound interest: investors who reinvest their bond dividends would end up with a portfolio that is 600 times more valuable than a non-reinvested portfolio.
Time in the market?
Little wonder, one might think, that financial advisors like to quote the old adage about time in the market being more important than timing the market. After all, the past century has seen the Great Depression, second World War, the oil shock-induced crash of 1973-74, Black Monday in 1987, the bursting of the dotcom bubble and the global financial crisis of 2008-2009, but stocks have always resumed their upward path; adjusted for inflation, US stocks have averaged annual returns of 6.6 per cent since 1925, while British stocks have averaged real annual returns of 5.6 per cent over the last 50 years.
However, the “time in the market” line is only half-true. Yes, as noted earlier, stocks almost invariably trump cash over 20-year holding periods, but some long-term investors get to enjoy a much nicer retirement than others. In the UK, for example, stocks returned average annual real returns of 11 per cent between 1975 and 1985. The following 10 years were almost as good, with annualised returns averaging 9.9 per cent. Real returns halved over the next decade, however, to 5 per cent, and slid to 2.3 per cent between 2005 and today, meaning British investors did better in bonds over the past 20 years. Earlier decades saw similar oscillations, with equity returns going from feast to famine.
Even over 20-year periods, returns vary widely; in the US, the worst average annualised 20-year inflation-adjusted return for equities was 0.9 per cent, says Barclays, compared to 13 per cent for the best period. To put that in perspective: a €10,000 investment compounding at 0.9 per cent annually over 20 years would be worth €11,962, but the same investment compounding at 13 per cent would be worth €115,230. It may be true to say that equity returns almost always beat inflation over 20-year periods, but such a statement masks the wild variation in returns seen even over lengthy periods. Historically, extending your holding period to 30 years has helped reduce, if not eliminate, the variation in returns. According to Ben Carlson of Ritholtz Asset Management, the worst 30-year period for US stocks nevertheless saw stocks appreciate by some 850 per cent. That may sound fantastical, but it equates to average annual returns of 7.8 per cent, or 4.1 per cent after inflation.
A sceptic might reply by mentioning Japan, where indices have halved since 1989’s bubble-era high, but equity bulls can retort with two points of their own. One, Japan is very much an exceptional case; the moral of the Japanese story, perhaps, is not that equities are to be avoided but that one should diversify internationally. Two, long-term equity returns in Japan have actually been quite strong; despite the bust, nominal annual returns have averaged over 9 per cent since 1970, courtesy of a mammoth bull run that ended when the bubble finally burst in 1989.
Conclusion
Equities are volatile and slavishly following market movements will ensure sleepless nights, but history indicates diversified investors with a long-term outlook are very unlikely to lose money. Cash may bring short-term comfort, but it will cost you in the long run.
However, while stocks have historically delivered real average returns in the region of 6 per cent, it’s not true to say that you will be guaranteed such returns if you simply sit tight indefinitely. Even over two or three decades, there is a wide variation in results. The longer you hold on, the greater the odds of securing strong returns, but the patient investor should remember this is a probability – not a guarantee.
