Mark Lister writes that if market returns are subdued, investors should focus on dividends.
Two thousand and 10 might seem rough but 1990 wasn't that flash either and markets have done fine since.
With so much uncertainty and risk swirling around the markets today, many people are understandably reluctant to invest at present.
In hindsight, today is somewhat reminiscent of 1990, although in many ways things were worse 20 years ago.
The early 1990s was a tough time for investors. Unemployment was close to 10 per cent, commercial property prices were collapsing, GDP was shrinking, inflation was 7 per cent and the floating mortgage rate stood at 14 per cent.
Our sharemarket had halved in value over the previous three years.
Then, just when you thought it couldn't get much worse, Saddam Hussein invaded Kuwait, sending the sharemarket down another 30 per cent.
Then we went through what Britain is facing now, big budget cuts, needed to fix a sick looking set of public accounts. Our economy, already suffering, rolled over. GDP fell further and unemployment pushed higher. Those were the days.
In the midst of all this terrible news, the New Zealand sharemarket quietly found a bottom in early February 1991.
It is important to note that this market bottom occurred some time before the economy reached a bottom, with unemployment continuing to rise until the last quarter of 1991, and GDP growth not entering positive territory until the last quarter of 1992, about 18 months later.
People who had the fortitude to invest during this maelstrom of bad news over 1990 have had a good run during the past 20 years.
New Zealand shares are up 320 per cent, house prices by 217 per cent and Australian shares have gained an impressive 538 per cent.
In fact, all assets did well. Fixed income, represented here by six-month deposits, returned 6.8 per cent a year before tax and 4.8 per cent a year after tax, still well clear of inflation, which rose 2.2 per cent a year.
Turning to today, what is the chance that returns over the next 20 years will look similar to those during the past 20?
Today, as in 1990, investors have plenty they can worry about. Sovereign risk, debt, budget deficits, inflation, deflation, weak house prices, rising interest rates, volatile sharemarkets, oil slicks and so on.
It is impossible to predict how all this will impact on markets and future returns.
But perhaps when considering the next 20 years, the Malagasy way of looking at the future may offer useful guidance.
In the English language, we describe the future as being "ahead of us" and the past "behind us".
In Madagascar, they do the opposite. In Malagasy, the future is said to be behind you and the past in front of you; the reasoning being that you can't see the future, therefore it is behind you, but you can see the past, so it is in front of you.
All thanks to Jen Hay, associate professor of linguistics at Canterbury University, who outlined this interesting gem on National Radio recently.
The Malagasy reasoning makes good sense to me, especially when it comes to looking at today's markets. All things considered, there is a decent chance that we could experience a Malagasy-type future over the next two decades where returns from markets could be similar to the returns we have seen over the past 20 years. History may well repeat itself.
So, we could be looking at 8 per cent a year or so from shares and property, and perhaps 6 per cent from fixed income.
Some readers will recoil at this. After all, who would invest in shares and property with the expectation of earning a measly 8 per cent return?
I certainly hope to earn more than 8 per cent a year from my share investments.
But I know that the market is going to struggle to give me any more than that. Any extra return will come from picking good quality stocks that pay solid dividends, and having the patience and fortitude to pick them up cheaply during those inevitable bouts of market weakness.
Perhaps another reason why so many people are reluctant to invest at present is not so much concern about risk, but an unwillingness to accept that returns will be lower than they expect, require or want.
But gone are the days of 10 per cent risk-free returns. In 1990, you could earn more than this from a term deposit - there was no need to even bother with risky investments like shares.
Today, buying a low-risk bond or deposit at a yield of 5 per cent or 6 per cent is clearly not going to net you a 10 per cent return.
We investors simply have to accept this new reality. When it comes to investment returns; 7.5 per cent is the new 10 per cent.
If market returns are subdued, investors in shares should increase their focus on dividends. Having a focus on dividends and, more importantly, dividend growth, is a good way to approach shares. Dividends are less volatile than share prices and it is also easier to tolerate the ups and downs in share prices if you are getting a dividend cheque every six months.
Also, dividend growth that shares can provide offers potential protection against inflation. Good companies should, over time, be able to grow their profits and dividends by more than inflation, providing investor protection against inflation. Dividend growth is arguably the single most important element of investing in shares. It provides inflation protection and drives any capital gain in share prices.
We recently had a look to see if New Zealand shares had delivered some dividend growth. Using the dividend data on the shares we cover, we estimate that the pre-tax average dividend yield across New Zealand shares was an entirely respectable 6.7 per cent in 1992.
At this time, the six-month term deposit rate was slightly higher at 6.8 per cent. Today, we estimate the pre-tax dividend yield on New Zealand shares bought in 1992 would have grown to about 9.3 per cent (on original cost), while the six-month term deposit rate has fallen to 4.6 per cent.
An investor who bought New Zealand shares in 1992 may have seen their income grow by 39 per cent, or 1.7 per cent a year, while the income from six-month deposits have fallen 31 per cent. The share portfolio should also have eked out about 2 per cent a year in capital growth.
With so many risks facing investors, a considered and careful approach is important. But investors who invest gradually, have a focus on dividends, take a long-term view and, most of all, have realistic return expectations, can continue to invest with a reasonable degree of confidence.
For sure, coming years will see the usual mix of volatility, risk and scary events. But by 2030, 2010 may end up looking a lot like 1990 does today. The future could well be behind us.
Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as specific investment advice.
