Investing For Growth: Equities remain long-term gamble

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The Independent Online
THE OLD SAW that the value of a share can rise as well as fall has never been as apparent as in the past few months.

Share prices have fallen and risen wildly, often in the space of a week, leaving many investors, large or small, unsure as to whether now is the right time to plough more of their hard-earned cash into the stock market.

Of course, we can all agree that over a long period of time it makes sense to invest in equities. But for many, there is still that fear of a looming stock market crash to hold us back.

After all, what happens if you invest on a Monday and by Friday the value of your holding has gone down by 10 per cent.

To take that argument further, if the markets really are so volatile at the moment, wouldn't it make sense to hold off for a few months more rather than pump money into equities immediately?

There are a number of issues to look at here. First, it is important to understand what kind of risk you are running when investing in equities.

There is "specific" risk involved in taking a risk with an individual company. Clearly, if you pick the wrong one to buy shares in and it turns out to be badly run, or the sector it operates in is going through a lean spell, then the company's share price may fall.

This is why it almost always makes sense to invest in a portfolio of shares, so that any risk may be spread out.

Alternatively, pooled funds, such as unit trusts or investment trusts, achieve the same effect, placing your money with that of many thousands of other investors.

The money buys shares in hundreds of companies, so that if one or two go belly-up, the fund itself won't be too badly hit. There is also "market" risk to bear in mind. This is where no matter how many otherwise sound companies you invest in, you will be clobbered by a "bear market".

This is where there are more buyers than sellers of equities: the options here are usually either to hang in there and wait for the market to recover, or sell at a loss.

There is a third option too: that of seeing that a fall also offers a buying opportunity. The lower prices are, the higher they will rise when a recovery occurs.

Of course, a canny investor might prefer to wait until the moment when the market has fallen to its lowest point before entering the market. Does this make sense?

In theory, it does. The problem lies in picking the exact moment to invest. Fidelity, the large US fund management group, carried out research on the period between the end of December 1986 and the end of December 1997, an 11-year period.

Fidelity's research over the period shows that the FTSE All Share index delivered annualised returns of 14.8 per cent.

But if you had missed out the 10 best days' growth over those 11 years, the annualised growth would have been 10.7 per cent.

Missing out on the best 40 days over the same 11 years would have delivered returns of just 5.2 per cent.

In other words, investment performance, while positive over the period, rose in a series of spurts.

Missing out on an average of less than four days' growth a year would have cut the average annual performance to almost one third.

A canny investor might agree with this but still hopes to get the investment period right. Again, Fidelity's researchers looked at the performance of the MSCI index (another way of measuring share prices) between the end of 1969 and 31 December 1997.

The study was based on three hypothetical investments made on the same day each year - at the highest point in the market (suggesting a poor investment strategy), at the low point (a "good" strategy) and at the arbitrary investment date of 1 January each year (how most of us are likely to invest).

At the end of this 27-year investment period, researchers calculated the annualised returns on each investment date.

Here are the returns: high point, 15.12 per cent; low point, 17.12 per cent; 1 January, 16.38 per cent.

While there is a difference in returns, it is not as significant as one might assume - and it is based on getting the investment timing exactly right every year, an unlikely scenario. There is, however, one way of minimising potential losses and enhancing gains.

Making regular investments offers the potential for "pound cost averaging". This means that if you buy into equities as their price is falling, you will receive more of them. In turn, gains that individual funds make will become magnified.

Here, despite the fact that share prices rose by 15 per cent in 12 months, the increase in the value of the fund was more than 25 per cent.

The message to take home is that for most of us, average investors, there is rarely a "right" time to invest. What we can hope for, however is that over a long period of time any sharp downward corrections can even themselves out.

And if prices are falling, then it makes very good sense to buy into a downturn.

`The Independent' has published a Guide to PEPs, which examines in detail the arguments about investing for growth or income.

For your free copy of copy of the guide, sponsored by Scottish Widows Fund Management, call 0345 678910.