Shares: why you need to think long term

When it comes to equities, or equity-based investment funds, a mantra often repeated is that equities should only be considered as a long-term investment.

Another much-repeated warning is that the past is not a guide to the future. This is also undoubtedly true, and should not be ignored.

So, how have different sorts of investments performed historically bearing in mind this can't be relied upon as a guide to the future?  The following table shows the real annual rate of return from equities and cash over a series of 10 year periods – that is, the annual return after accounting for price inflation.

Period

Equities

Cash

1905-1915

-0.2%

-0.5%

1915-1925

3.9%

0.8%

1925-1935

8.7%

4.7%

1935-1945

2.4%

-2.3%

1945-1955

5.3%

-3.0%

1955-1965

7.3%

1.8%

1965-1975

0.1%

-1.4%

1975-1985

11.0%

1.5%

1985-1995

9.9%

5.2%

1995-2005

5.0%

2.9%

2005-2015

2.3%

-1.1%

In none of these ten-year periods does cash beat equities. And, in five of these eleven ten-year periods, cash savings are worth less in real terms at the end of the period. In other words, cash savings at the end of the period wouldn’t be sufficient to buy the same amount of goods and services as at the start of the ten-year period.  

Historic data shows that although volatile, holding equities over longer periods does produce better returns than other investments most of the time (we’ll cover the historic returns from bonds in next month’s Thinking Ahead).

Another way of looking at historic data is to consider the probability of equities beating cash over different consecutive periods. The following table shows rolling 2, 3, 4, 5, 10 and 18 year periods from 1899 to 2015 inclusive. For example, there are 112 five-year periods that run 1899-1904, 1900-1905 etc. to 2010-2015. Of the 112 five-year periods, equities outperform cash in 84 of those time spans, giving a probability of equities outperforming cash of 75%. 

 

Number of consecutive years

 

2

3

4

5

10

18

Total number of x year periods from start 1899 to end 2015

115

114

113

112

107

99

Number of x year periods equities outperform cash

78

80

82

84

97

98

Probability of equities outperforming cash

68%

70%

73%

75%

91%

99%

As you can see, based on historic data, the longer you hold equities, the probability that they outperform cash increases, with historic 18-year periods indicating that equities outperform cash 99% of the time. Of course, no matter what probability might suggest, you should always remeber that past performance is not a guide to the future. 

The returns from equity investments also show a link to both inflation and the general rate of economic growth (gross domestic product), although these factors are not always synchronised. This is logical because, generally speaking, a company’s performance depends on how the economy is growing and how much income its customers have to spend. A company’s costs also depend on inflation, which drives up the costs of things like raw materials and transportation. In response, businesses generally put up prices to reflect their increased costs.

As a result, investing in equities is regarded as a good hedge against inflation. 

As previously mentioned, no one knows what the future might bring, and it will almost certainly be different from the past. 

 

You might also be interested in…

Stocks, shares & equities: what every investor needs to know

Shares: are there good and bad times to buy?

AR01893   01/2017

 

 

 

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