One of the most frequently quoted pieces of investment advice is
that equities are a good long-run investment.
The argument runs that for all the ups and downs of the stock
market equities outperform other assets, such as cash or government
bonds, in the long term.
Like much investment advice this one comes with caveats, in this
case two rather hefty ones.
The first relates to "the long term". Over the
last century UK equities have had some periods of terrible
performance, where investors either lost money or would have done
better holding other assets. At some times in the last 110 years
you would need to hold UK equities for more than ten years to make
up for periods of underperformance.
The second caveat is the money-making properties of equities in
the long term relate to their performance in the past. There is no
certainty that history will repeat itself. In the familiar words of
the health warning that accompanies most retail investments,
"past performance is not an indicator of future
The annual Equity Gilt Study, sponsored by Barclays, provides an
excellent starting point for thinking about these issues. The Study
has been published every year since 1956 and is a goldmine of data
on the long run performance of UK and US equities.
They confirm that equities have given good returns over the very
long term. Over the last 116 years UK equities have returned an
average real return after inflation of 5.0%. At this rate of growth
the magical power of compounding leads to large gains over time. A
5% annual return increases the value of an initial £100
investment to £163 in 10 years, £265 in 20 years and
£1147 after 50 years.
Equities do well when growth is strong, even if, as in late
1970s and early 1980s, it is accompanied by high inflation. Good
growth boosts profits and company valuations and many businesses
can compensate for high inflation by raising prices.
Conversely periods of weak growth and low or falling inflation,
as was seen in the Great Depression of the late 1920s and early
1930s, are bad news for equities. Between 1928 and 1931, when
consumer prices fell 12%, UK equities lost almost half of their
value. US equities fell by more than two thirds.
The period that started with the Global Financial Crisis, in
2006, has been a milder version of the Great Depression, marked by
sluggish growth and weak inflation. It has been a difficult
environment for equities. UK shares have given an average real
return of 2.3% in the last 10 years, half that seen in the last 116
The asset that has thrived has been government bonds. These are
loans made by the private sector to government and are initially
sold yielding a fixed interest rate. If inflation and market
interest rates subsequently fall, as they have in the last 10
years, the value of bonds goes up. Bonds have the additional
advantage over equities that governments do not go bust. At an
extreme a government can print money to repay its debts. In times
of uncertainty the guarantee that you will get your money back at
the end of the investment term is a highly attractive
In the last year UK government bonds have returned an average of
3.0% a year in real terms compared to a 2.3% real return on
Japan provides a longer run and more extreme example of
deflationary conditions hitting equities. Japan's long post war
boom came to an end in 1989 with a spectacular collapse in its
equity market (you get a sense of the scale of the value
destruction from the fact that 27 years later the Japanese equity
market is trading at about 40% of its 1989 peak value). From being
seen as the economic powerhouse of the global economy, Japan ended
up portrayed as an ageing, deflation-prone growth sluggard.
Slow growth and falling prices have been bad news for holders of
Japanese equities and great news for those who invested in Japanese
government bonds. A back of the envelope calculation suggests that
£100 invested in Japanese equities in 1989 would, even with
all dividends reinvested, be worth rather less than £100
today. If you'd put the same money into Japanese government
bonds you would have an asset worth £250.
Equities did well in over time in the twentieth century against
a backdrop of buoyant growth and generally positive inflation. The
post-Lehman world of slower, volatile growth accompanied by low or
falling inflation has proved much more challenging.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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