Brent Sheather: In for the very, very long haul

The stockmarket goes up and the stockmarket goes down.

While upward movements may be pleasant for Saturday reading the latter effect can cause problems especially if your financial plan relies on capital gains to produce income.

In fact, whenever Mum and Dad express worries about a big fall in their portfolio to their stockbroker or financial planner they are inevitably assailed with the mantra of "invest for the long term, buy and hold, and you will be OK".

The conventional wisdom is, among even conservative advisers, that you shouldn't try to time markets but if you can hang in there for 10 years you will be laughing all the way to the bank.

The flip side of the argument is that anyone who sells out at the first sign of volatility is an idiot and they are somehow wrecking it for everyone else.

But just because someone says something doesn't make it so, no matter how sensible they might look, or how often they say it.

Recently stockbroking heavyweight Merrill Lynch produced a report which showed that the chance of losing money in the US stockmarket declines as the investment time horizon lengthens.

Thus if you invest for one day your chance of losing money is 46 per cent, if you hang in there for a week that falls to 42 per cent and if you can manage to keep your hands off your mouse for a whole year you have only an 18 per cent chance of a loss.

Lock your stocks away for 10 years and historic probability says you can't lose. Or can you?

There are two important caveats to the conclusion that 10 years is long enough to underwrite a positive return from shares: first, the argument is inevitably based on US data but there are stockmarkets other than that of the USA and, second, the performance of the US market over the most commonly used timeframe, 1926 to 2006, has been extraordinarily good and is unlikely to be repeated.

The weakness of the "invest for 10 years and you will be right" argument can be seen by looking at the historic performance of our own NZX-listed international equity trust, the WiNZ Index Fund.

WiNZ is an index fund that tracks the performance of the world's largest stockmarkets and it has been listed on the NZX since August 6, 1997.

If you bought 10,000 shares in WiNZ about six years ago on 01/08/2000, at its all-time high of $2.53, you would today be looking at a loss of 44 per cent and that is before the impact of inflation.

More importantly, in order for Mum and Dad to just get their money back over 10 years WiNZ shares need to return about 15 per cent a year in the next four years, highly unlikely given that virtually all the unbiased commentators in the world say we will be lucky to get an 8 per cent a year total return from global stockmarkets, and that is before fees.

Remember, too, that these numbers are in nominal terms but Mum and Dad could reasonably expect to get a positive result in real terms, ie after inflation.

All in all it looks very much like investors who bought WiNZ in August 2000 will not get their money back despite hanging in there for 10 years.

If international shares return 8 per cent a year from today, WiNZ shareholders will probably have to wait seven years just to break even in real terms.

It is also important to be clear that the poor performance of WiNZ has nothing to do with bad management, it is an index fund which tracks the market. The problem is simply that markets were much too high in August 2000.

Much of the perception that shares were a sure bet long term was based on the pioneering work of Ibbotson Associates, who produced a definitive set of data measuring the returns on US shares, bonds and bills going all the way back to January 1926.

But not everyone lives in the US. So Elroy Dimson, Paul Marsh and Mike Staunton, professors at the London Business School, have done for the rest of the world what Ibbotson did for the US. Their analysis highlights the fact that, compared with most countries, the long-term performance of the US sharemarket has been exemplary.

But if you lived in St Petersburg in 1900, put all your savings into a Russian index fund and crossed your fingers, you would have lost the lot.

Dimson, Marsh and Staunton show that over the 103 years of data they collected, US shares have returned a positive real (after inflation) return over every 20-year period - 1900 to 1920, 1901 to 1921 and so on. But in other markets - Japan, for example - almost one-quarter of all the 20-year periods have been negative.

One needs to expand one's horizon to 50 years for returns from Japanese shares to have been consistently positive. Not many recently retired investors can afford to wait for 50 years.

The three professors' analysis shows that in most countries investors have to give the market much longer than in the US before they can be guaranteed a positive return.

Of all the countries surveyed, Japan's experience is close to the median. If the non-surviving markets from 1900 (such as Russia and China) are included in the comparison, then Japan has done better than most.

"Over the last century, taken as a whole, common stocks have indeed been attractive investments," says the study. "But they have not consistently been attractive over a horizon of just 20 years. In many countries, stocks have done well only over the exceptionally long run.

"Moreover, periods of underperformance can be more severe than has been experienced within the United States, and the duration of underperformance may, on past evidence, persist for several decades."

* Brent Sheather is a Whakatane-based investment adviser