It can be a bit of a hard sell, though. At the risk of offending our more youthful readers, I would say that young adults tend to be a little more impetuous than their aged counterparts. This can lead to bad outcomes.
You do not have to be an authority in behavioural finance to realise that investors overreact more to negative events than positive ones, especially for the uninitiated. It is understandable why investors new to the game might decide to head for the exit once paper losses start to mount. After all, limiting the extent of your losses when you are wrong is every bit as important as how much you make when you are on the money.
Unfortunately, inexperienced investors are in the habit of crystallising unwarranted paper losses. A stock price can always slide in reaction to a general index contraction, or unfavourable economic news, even though there have been no fundamental changes that impair the value of the underlying business. This helps to explain why stock prices tend to dart around more than intrinsic business values.
There is a flipside to all this – the danger of self-attribution, which is always a potential vulnerability if your early investments have headed in the right direction. It is essentially a form of confirmation bias, and completely at odds with an appreciation of the limits of your own knowledge – Socratic wisdom. Just because trades have been running in your favour, it does not mean you have sussed the market.
The concept of time horizons in investments also seems to carry less weight when you have just stepped out of short trousers. Though it is generally accepted that an investor will become more risk averse as their portfolio matures, it does not follow that young investors should throw caution to the wind, even if they believe that their existing portfolio is not capturing all of the growth on offer in a given market.
Winston Churchill once described private enterprise as “the strong horse that pulls the whole cart”. For inexperienced investors, the equine metaphor is particularly apt, in that they should be looking to harness the market rather than necessarily beat it outright. Stock-pickers can, and do, regularly beat alpha; otherwise, we would be out of business. But it takes time to build knowledge and, if you are just starting out, it pays to remember that individual stocks carry a heavier burden of proof than simply hitching your wagon to a benchmark index.
Q: How do you double the value of your investment capital?
A: Buy a FTSE 100 tracker and wait nine years and 84 days.
Since its inception, the FTSE 100 has returned 7.78 per cent per annum on a total return basis. You can work out approximately how long it will take you to double an investment by simply dividing 72 by the annual rate of return – the so-called Rule of 72. If, instead, you had opted to track fast-growing emerging market economies, say, via Schroder Asian Total Return, you could theoretically expect the cycle to contract to just six years and 113 days.
The FTSE 100 has been in existence since 1984, and the rate of return has oscillated over the years, but it can be demonstrated that the index usually retraces significantly in the year after it hits a trough. Many of its constituents may be deemed ex-growth and some analysts maintain that it remains too heavily weighted towards energy stocks, but it is not as volatile as other national indices, and it has several reliable income generators in its ranks, at least until recent events. The good news is that emerging market indices, though somewhat more volatile, are deriving a rising share of their total return growth through distributions to shareholders.
Reinvesting dividends is the key to growing wealth over the long-run, so the spate of top-tier dividend deferrals and cancellations is certainly worrying. But if you have been unfortunate enough to have made your initial foray into the market in the early part of this year, you should still appreciate that it is easier to compound, rather than trade, your way to financial security.
