The challenges of investing in shares (equities)

Shares (Equities) investment refers to the buying, holding or selling shares in listed companies on a stock market. The aim is to generate annual income from dividends (ideally with franking credits) and generate capital gains. You are backing the ingenuity and creativity of a fellow human being(s) to generate value which eventually translates into higher share price and wealth to you.

If we look at very long periods of time, conventionally 20 year calendar periods, an accumulation index style investment in shares has consistently generated an average annual rate of return of about 10% per annum (ignoring expenses and franking credits). Generally every twenty year period, no matter when you started, has seen several bear markets and several bull markets but they average out to this magical 10% per annum. The bigger the bear market the bigger the recovery. The market has absorbed such declines as we saw in 1929-33 and 1972-4 and 1987 and 2000-3 by rallying hard to hit new highs and retain the 20 year record.

On most occasions (but not this most recent time) the new high is seen within five years of the low. For this reason most PDS documents state you should only invest in equities if your time horizon is at least five years (although I suspect the rationale is not understood by the marketers who write it or the legal and compliance people who sign off on it).

On very rare occasions, generally after three year bear markets, it has taken seven years to reach the old high. For the Australian market to maintain its record it must achieve a new high by the close of 2016. This looks unlikely as I write in December 2015.

For this reason most investment products cite a 10% long term average return on equity investment. This long term average outperforms direct property ownership, fixed interest and cash deposit offerings.

The extreme pessimists will point to the Japanese market. The bubble burst more than 20 years ago and it is still far from it's old highs. I could spend an evening over dinner explaining why this is probably not a relevant example so I shall not try to go into it here.

However demographics will remain unfavourable for years and interest rates are very low and as they rise that will create headwinds too. It seems to me passive investment in a few blue chips or an index, which has worked passably in the past for retail people to build wealth doing their own thing, is already failing babyboomers now.

Babyboomers face the double whammy of falling long term returns, with increasing life expectancy. Getting out of shares is not an option for most unless you want to embrace government assisted pension living.

Share ownership is attractive because:

But there is the day to day, month to month and year to year volatility. The sad fact is that that research demonstrates that even quite sophisticated investors including investment institutions end up holding high exposures to shares towards the highs of markets and then panic out and sell towards the lows. If institutions like insurance companies get it wrong so often, what hope is there for ordinary folk?

During my 40 years of studying and investing in equity markets, I have learned that few people have the resolve or true understanding of risk that allows them to buy things when everyone else is sceptical, and sell things when they become very popular but risky, and face the wrath from the public that each decision brings.

I spend a lot of my investment life doing the opposite of what most people are doing, and it is this largely contrarian approach that has led to most big successes.

It's hardly surprising therefore that I advocate passing responsibility for actively managing your portfolio to professionals and getting on with other aspects of life.

Major observable disadvantages of direct shares and doing it yourself

Some of the more acute disadvantages of owning shares in your own name are:

FORTUNATELY YOU CAN GREATLY SIMPLIFY YOUR LIFE, AND OF THOSE THAT FOLLOW YOU, BY HOLDING YOUR DIRECT SHARES IN A MANAGED ACCOUNT. YOU CAN CONTINUE TO MANAGE THE PORTFOLIO IF YOU WISH VIA AN ADVISER OR SELECT AN ACTIVELY MANAGED PORTFOLIO (OR A COMBINATION).

John Aldersley