Since hitting the bear market low in March last year the share market has gained an impressive 56%. Although the damage done by the worst financial disaster in decades was not insignificant, the most dire of predictions failed to pass and we are increasingly seeing more cause for optimism. Though any recovery may indeed be difficult, prolonged and uncertain, there is money to be made.
Nevertheless, many investors are still seeing a lot of red in their ledgers, and prospective investors remain understandably sceptical. Who could blame them? We may well have seen a strong turn around in share prices, but we still remain a solid 30% below the market’s all time high. And within the broader mix the situation has been particularly harsh for certain companies. A rising tide does not necessarily lift all ships, and sadly once mighty names such as Babcock & Brown and ABC Learning lie rusting on the ocean floor. Moreover, many dark clouds remain visible and the prospect of the dreaded ‘double dip’ remains a viable one.
So are you a bull or a bear? Both sides make good cases, yet neither has a decisive argument. The stakes are high, with healthy returns chanced against the potential for further crippling losses. Timing, as they say, is everything. Or is it?
Whether you are successful or not in the market depends largely on what it is you set out to achieve. If your goal is one of vast and easy returns, you will most likely fail, no matter how gifted or well prepared you believe you are. But what if what you desired wasn't directly associated with the ebbs and flows of the market? What if you goal was to build an ever growing stake in a range of quality, reliable businesses, ones that pay you a reliable, growing and tax effective income? Your success is virtually guaranteed, for all that this demands is a policy of regular saving and buying.
But aren’t you still subject to the rise and fall of prices? How can you ignore something as critical as the value of your assets? As regular readers know, I’m not a great fan of property investment, but I do envy the mindset that property investors’ hold. Unlike stock investors, they understand that their asset’s true value lies in its ability to generate a passive income, one that will most likely rise over time at a greater rate than inflation (which incidentally will in turn act to support a rising asset price).
Property investors don't get their assets valued very often, certainly not several times a day. Why would they? So long as the rental return keeps rolling in they are happy. When they build up sufficient equity, the use this to buy another cash generating machine (ie property) and thus expand their income stream. The end goal is to hold a large quality set of assets that cover all expenses and provide an attractive income, one that requires virtually no work to generate. As for selling, why would they? Maybe if a large amount of capital is needed, but outside of that selling only acts to erase the flow of funds into your bank account. A pile of cash is useful when you need to buy something, but it provides very poor investment returns – it could be working much harder for you elsewhere.
So who cares what will happen to the wider market over the next few years? If I don't expect to need access to my capital, I want it working for me to provide me with a stream of income. When it comes to shares, that income is admittedly small in the first few years, but when you consider that it tends to grow at about 7%pa, it very quickly becomes attractive, indeed your yield will most likely double over the decade and continue to keep rising from there.
But the real value in this income stream, at least for those not currently retired, is that it can be reinvested and act to compound your returns. Exponential growth is a thing of beauty, but only the patient investor will ever allow it to blossom.
If the economy does indeed deteriorate and the bears are proved right, the level of dividends may well suffer, but then again so will interest rate based securities and property. A struggling economy isn’t good news for most assets, and while share prices will suffer more than most, they will also recover faster and better than most too, and the experienced volatility will ultimately have little impact on your long term returns. This is especially true when you have a policy of making regular purchases, as this will ensure you buy shares when they are cheap as well as expensive, and you will average out your purchase price.
Take for example the recent market downturn. Let’s say that you invest $10,000 the day before the all time high, and then add an additional $1000 every quarter. Dividends are reinvested along the way.
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Although the market (as represented by the ASX 200 Accumulation index) is still 20% away from its highs, a policy of regular saving and investing has meant that you have suffered an almost insignificant 3% loss of capital; not bad considering we are only a year away from the low of the worst bear market in a generation! I’m not saying this is the ideal situation, but it demonstrates that even the worst possible timing does little damage from a long term perspective.
The important thing is that you have a pool of capital at work in the best asset class around, quietly and reliably generating cash that you can spend or reinvest. If the market tanks from here, your regular investments will again ensure your capital is ok over the long term, but if the market rises, you will of course reap immediate reward. In either event, the long term investor should, as always, buy and buy often.
Make the markets work for you!