Investment: Wisdom of old can be bad for your wealth
It took nearly 30 years of disastrous post-war inflationary experience for the last generation to learn quite how stupid it was to lend money to the Government
Wednesday 17 February 1999
For decade after decade, successive governments have borrowed money from their citizens in order to plough the proceeds into more or less dubious ventures, from war to make-work, buy-vote schemes of little enduring value.
The long-term figures tell a grim and mostly unremitting story. If you had lent pounds 100 to the Government in 1918, by buying what still goes under the gloriously euphemistic name of gilt-edged stock, your capital would today have a purchasing power of precisely pounds 3.86.
Had you put the same amount of money into the stock market in 1918, your capital would today be worth pounds 1001.60 in real (inflation-adjusted) terms. In other words, while committing your savings to the private sector would have grown the value of your money 10 times in real terms over the last 80 years, those who lent their savings to the Government instead have seen 96 per cent of their capital wiped out.
No wonder that Dr Johnson opined that patriotism was the last refuge of the scoundrel.
Inflation of course is the big stick that wipes out value in the gilt- edged market. Because the coupons (interest payments) on government stock are fixed in advance, any change for the worse in the value of money works to the advantage of the issuer by eroding the value of the amount he owes.
It took nearly 30 years of disastrous postwar inflationary experience for the last generation to learn quite how stupid it was to lend money to an institution (government) which has at the same time abrogated to itself the power to devalue the currency in which it has borrowed.
It is no surprise that those who suffered the indignity of seeing their savings wiped out in real terms should largely have sworn never to lend to the Government again. Yet the trouble, as so often in matters financial, is that those who live in the past are condemned to repeat the mistakes of their predecessors.
Any investor who today turns his back on government stock, or other fixed- interest securities, is risking just as much by not investing in that medium as his or her parents did when they opted to entrust their savings to the capricious care of the state all those years ago.
The latest annual historical survey of equity and gilt returns by Barclays Capital, just released, underlines quite how dramatically the equation has changed in the last decade. For headline writers, the big feature of the 1990s in investment terms has been the continued dramatic strength of the world's stock markets.
Last year was the eight time in 10 years that shares have produced double digit returns - a record of sustained bullishness that is unmatched by any previous decade in the last 200 years.
Yet the market performance which in truth deserves most attention in the 1990s is not the gravity-defying behaviour of the stock market - which is clearly operating at an unsustainable level of overvaluation - but that of the bond markets.
One hundred pounds invested in gilts in 1990, according to Credit Suisse First Boston, would today be worth pounds 243 in real terms; the same amount invested in equities would be worth pounds 275.
Allowing for transaction costs and taxes (both effectively higher on shares than gilts), there is no doubt that gilts have been at least as good an investment as shares - and this, remember, in an equity bull market of epic proportions. The message becomes even clearer when you look at the risk side of the equation.
For some years now, every time a computer has been asked to crunch the numbers and produce an optimal portfolio, measuring returns on different classes of asset against their perceived risk, it has come up with the conclusion that most investors should have a 100 per cent weighting in shares.
However, all these optimisation exercises make the classic boffin's error of inputting historical rather than forward-looking data for returns and asset volatility.
If you look forward rather than back, and adjust for risk in a world where inflation and interest rates continue to fall, it does not require a first class degree to realise which class of investment has actually been riskier.
In fact, the latest optimisation exercise carried out by Barclays Capital gives a prominent place to gilts.
For all but the highest risk takers, it suggests, even an investor blessed with 100 per cent foresight should have put at least 40 per cent of his portfolio into gilts and/or cash rather than betting everything he had on the overvalued equity market. Among the most impressive performances of the gilts market last year was the strong showing of War Loan.
The price of War Loan rose in 1998 and now trades at 76p in the pound, an event which it is safe to say few experts ever thought they would live to see. Now War Loan is one of the best performing investment classes of the year (perhaps, if yields continue to fall, even in danger of being redeemed, which would be something.)
Nevertheless, its dramatic price recovery is a pointed reminder that those who want to maximise their investment returns must always ignore yesterday's conventional wisdom in favour of an open mind about what might happen next.
At the risk of generalising, nothing is usually more injurious to your wealth than to listen to the wise words of previous generations, their assumption being that the future would be altogether like the past, which of course it never is - as even Voltaire knew.
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