Personal Finance: The Jonathan Davis Column: Rip Van Winkle had the right idea

What is the most important quality you need to be a successful investor? I put the question earlier this year to Michael Hart, one of the City's longest-serving fund managers and the man who, until retirement this summer, had been looking after investment policy at Foreign & Colonial for no fewer than 28 years.

His answer was: "Not to have too excitable a disposition." Looking back on the events of the past week, which certainly merit the description exciting, it is not difficult to see what he means. It is too easy to get caught up in the sense of drama and hysteria which tends to grip even normally sane individuals. Monday's experience, with Wall Street down by more than 9 per cent at one point, and stock markets all round the world following suit, was a telling reminder of how deeply ingrained the fear of a share price collapse still seems to be in our national consciousness.

What do the events of this week mean? Here are some, I hope suitably unexcitable, observations.

The drama on Monday was not the precursor of a market collapse, but a necessary phase in the long overdue correction of an overvalued market. It happened to be concentrated into a remarkably short space of time and is probably not yet over.

The fact that Wall Street's fall was mirrored to varying degrees in virtually every market in the world tells us something about the globalisation of the world's markets.

The trigger for the stock market fall on Monday was the loss of confidence in the Far East markets, with the Hong Kong market the worst affected. The Hang Seng index is down by 40 per cent since August. But bear in mind that the Hong Kong market has always been volatile, with many of those in the market using borrowed money to speculate on share price movements.

There are genuine economic and financial problems in several of the so- called Asian tiger countries. If they persist, they cannot fail to have some impact on Europe and the United States. Yet it is difficult to detect any fundamental reason why one should start to fear a profound or global economic crisis.

That being the case, in several conversations with seasoned investors this week, I failed to find one who does not believe that what we have seen this week is primarily a reflection of concerns about the overall valuation of the US stock market. The Far Eastern problems may have been a catalyst, but they are not the cause of the current market jitters. (Note that Brazil and Mexico, which are in the same time zone as the United States, were the two markets most affected by Monday's crash, falling 14 per cent and 12 per cent respectively).

Nobody who reads this column will be surprised to hear my view (a) that the US market has become worryingly overvalued in the past two years; but (b) that as all markets are driven in the short term by flows of money, which are not always entirely rational, there is no reason why an overvalued market has to correct immediately.

As the charts show, on conventional valuation criteria, such as dividend yields and price-earnings ratio, the 15-year bull market in shares has taken the US market into territory where historically warning signals have always started to ring.

The likely rate of growth in future company earnings cannot sustain current valuation levels. So at the very least, a period of relative underperformance is likely at some point over the next two to three years.

On the other hand, while reality must eventually intrude, medium and long-term bond rates have still not started to rise, as one would expect if we were facing an immediate or potentially damaging crisis. As a result, equities are still the destination of choice, for example, for anyone planning a pension, provided you accept that future rates of return will be lower than the exceptional ones achieved over the past 10 years. Even with perfect foresight, the right question to ask is this: would you be happy to give back all the rises you have had to date solely in order to avoid a coming fall of this size?

If you are buying shares as an investment, rather than as a speculation, you are doing so because you have taken a three to five-year decision, if not longer, to tie up your money in this way. The only sensible way to look after your holdings in such circumstances is to stick with your original decision, unless and until you have some compelling cause to change your mind. A sudden movement in the current prices quoted in the market is not a sufficient reason.

In theory it should make little difference if a market falls by 3 per cent for three days running, or by 9 per cent in a single day, provided that the final outcome is the same. That is easy to say, but of course, as Mr Hart observes, it always feels different at the time, which is why a 9 per cent one-day fall in the stock market dominates the newspapers and the TV bulletins, but a 20 per cent rise over, say, a month rarely gets a mention.

Over any five-year period, wrote the American security analyst Ben Graham, "the investor may as well resign himself in advance to the probability that most of his holdings will advance 50 per cent from their low point and decline the equivalent of one-third or more from their high point at various periods". The wise investor, thought Mr Graham, should be like Rip Van Winkle, snoozing on and pausing only from time to time to see whether the market, in one of is periodic bouts of frenzy, was offering any exceptional bargains.