This is a very curious question to ask especially when we are the people that give advice to our clients and often recommend investments but it is a question that is still worthy of examination.
I think that we all know the answer to this question, investing is very much worthwhile but this statement is always subject to the usual industry caveats (see footnote) and we need to acknowledge the maxim of risk vs reward, this really is relevant. Risk does determine reward, a lottery ticket is relatively cheap and not an investment but the potential for reward is high as is the potential for loss.
Investing in just one company has the potential for some rich rewards but also for some extremely heavy losses but investing in 200 good quality companies is likely to temper both of these potential outcomes.
EXAMPLES
We also know that investing isn’t simple and we all know that investing can go wrong at times. Fortunately it can also go right. Here are some company names that you might recognise:
Kodak, DeLorean, Commodore Computers, Nokia, Woolworths, Enron, Lehman Brothers, Northern Rock. On the flipside there are some real successes which could include: Amazon, Apple, Microsoft, etc, and in their time: railways (Cornelius Vanderbilt); steel (Andrew Carnegie); oil (Standard Oil / Rockefeller); banking (J P Morgan/Richard Mellon).
THE COMPLEXITY OF THE MIND COUPLED WITH OUR EMOTIONS
For those wanting a deeper dive into the workings of the human mind in these situations, look up Prospect Theory. It was developed by Amos Tversky and Daniel Kahneman in 1979 as a way of analysing why people make choices with their finances. Broadly put (and this was complex work for which Kahneman won a Nobel Prize) it proposes that people feel their losses far more than their gains, and will then make decisions accordingly.
With all of this complexity at play, we come back to our original statement – it’s time in the market that’s going to pay off, rather than the stress of trying to get the timing in the market right and make decisions.
What’s the first step to achieving this? Don’t look at your investments every day! Markets react to news, which can break in seconds. No one can predict this and staying out and trying to get in quickly can lead you to miss a rise. If you’re hell bent on the crystal ball approach, you may well miss a surge, whereas if you sit it out, turn off the updates and go and do the gardening instead, you may well just ride the rise.
TIME IS A FRIEND…STATISTICALLY SPEAKING
We absolutely need to give our investments time to work. It is certainly worth recognizing that our ability to live with volatility and remain invested through prolonged periods when markets fall is truly critical – we need to keep the faith. Recent market turmoil is an ever present reminder that investments may not make money as quickly as we might like.
GLOBAL EQUITIES
This image plots the rise in the value of global equities. Despite all the various crises; markets have simply marched on and over the 34 years illustrated the returns are more than worth the risk. The problem is…we do not want to wait for 34 years for a return on our investment. Fortunately, for every year of negative returns, on average there are four years of positive returns.
TAKING RISKS
There are one or two other key takeaways and one is how contradictory we can be as human beings. Of course any investor would want the highest possible reward especially with almost no risk but sadly this is clearly impossible. This doesn’t mean that we have to all buy a lottery ticket but we shouldn’t expect £1m+ if we don’t make that purchase.
So – risk does equal reward and one big price that we pay for trying to achieve healthy returns is volatility; the rise and fall in the value of any investment and sometimes this volatility can persist for longer than we anticipate.
I think too that it is really important to take enough risk. It is too easy to look back and regret not taking enough risk.
I am looking forward to the year ahead and expect markets to have a positive year!
Source: Bloomberg, Goldman Sachs, SJP, BBC News.
Where there are any figures that refer to the past, those figures and that past performance is not a reliable indicator of future results.
