Rewards For The Brave

By Mary Holm

Tuesday 18th September 2001

Tuesday, September 11: Here's an interesting paper. Called "Lessons From A Difficult Year", it says investors shouldn't bail out of global shares. I'll write my next column about it.

Wednesday, September 12: Terrorists strike the US. Share trading there is halted, but prices seem sure to fall when the market opens. Should I still write that column?

After talking to various experts, including Paul Dyer of AMP Henderson Global Investors who wrote the paper, I decided that, if anything, the message should be louder: Stick with your world shares. Perhaps buy more.

"Most crises seem worse at the time than they turn out to be," says Dyer. "Times like this are emotional, but they're not very economically significant. They can be good buying opportunities."

This is especially true given that world share prices were already well below a year ago, before the terrorist attacks.

The fact is, though, that at times like these, many investors sell rather than buy.

"Reacting to market falls by withdrawing funds is fatal," says Dyer in his paper.

He uses US data because it's readily available, but adds that results would be similar elsewhere.

Looking at the market since World War Two, he says, "The 56 years of overall prosperity were punctuated by ten episodes where shares fell 15 per cent or more."

The last decline was in 1987, leaving an unusually big gap until 2000. The average decline was 23 per cent, and periods of decline ranged from three to 21 months, averaging 13 months.

But - and here's a major point - in the 12 months following each decline, returns ranged from 8 to 57 per cent, averaging a very healthy 32 per cent.

"This is not an exploitable result," Dyer adds. That's because we don't know, until afterwards, when the market has hit bottom.

"But," he adds, "it does strongly caution against being out of markets after a substantial fall."
Looking back over the last 200 years, he says the strongest five-year period of returns was, surprisingly, during the Great Depression.

From May 1932 to May 1937, US shares returned a huge 367 per cent. The many who sold shares during the 1929-32 Crash would have deeply regretted that move.

Presenting his case another way, Dyer says people who use "hindsight investing" can halve their returns. He gives two cases:

- Each year an investor puts his money into either shares or cash, depending on which had the higher return the previous year.

That means he would have held cash in 17 of the last 55 years.

His real (inflation-adjusted) returns would have been 5.1 per cent a year over that period. But if he had stayed in shares the whole time, they would have been 10 per cent.

What's more, for the 17 years he was out of the market, the average annual return was 17.4 per cent.

- "But", asks Dyer, "is this what investors actually do?

Using data on money flows into managed funds, he looked at what would happen to a typical person, whose monthly investments rose and fell in proportion to those flows. When everyone put in more, so did our investor.

Dyer compared this with someone who invested the same amount each month. The latter person's returns were almost 50 per cent higher.

"On average, US investors have received only about half the returns they could have had through a more disciplined approach."

He concludes by saying $1 invested in global shares in 1970 is now worth $61, compared with $21 in the bank.

"This excess return exists because sharp declines like this one happen periodically, and not everyone has the stomach to ride them out."

Be one of the brave ones!

Mary Holm is a freelance journalist and author of "Investing Made Simple", commissioned by the New Zealand Stock Exchange to write an independent personal investment column. She can be reached at maryh@pl.net. Sorry, but she cannot respond directly to readers.

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