After the market’s strong start to the year, it may be tempting to abide by the adage to ‘Sell in May and go away, buy again St Leger Day’ – a date linked to the famous horse festival in September bearing the same name. It dates back to a time when travel was slow and information intermittent, so City investors would take long summer holidays and the market would essentially close.
But the evidence suggests this particular adage does not stand up to scrutiny. As such, long-term investors should not be distracted from adhering to the fundamental principle that ‘time in the market is better than timing the market’ – as trying to time market swings has tended to be a fool’s errand. Such an errand can also reduce an investor’s ability to benefit from what is the major contributor to total returns – reinvested dividends.
Yet in adhering to this investment principle, investors need to recognise the importance of ensuring portfolios consist of the right balance of asset classes to best achieve their remit. Appropriate diversification is essential as an investment journey progresses and financial goals are approached. This discipline certainly guides the nine real investment trust portfolios run in real time by our company on the website www.johnbaronportfolios.co.uk.
The evidence
Recent research by Hargreaves Lansdown suggests that £10,000 invested in the FTSE All-Share when it was launched in 1986 would now be worth around £198,000 if dividends had been reinvested. The figure falls to £125,000 had the portfolio been sold in May and reinvested in September. An interesting observation is that, over this period, June proved, on average, to be the only month when markets retreated – and then only modestly.
This evidence apart, there are a host of reasons for long-term portfolios to stay invested. For one thing, the longer invested, the more chance of a positive return. Research from Fidelity a few years ago showed that investing in global equities for 12 years or more produced no negative returns over the period 1980-2012 – whereas five-year periods produced a 16 per cent chance.
As for timing the markets, Fidelity research further suggested that missing the best 10 trading days over a recent 10-year period would have produced negative returns of -4.6 per cent, and missing the best 20 would have extended the loss to over -32 per cent. An investor would have to have been unlucky, but the point is well illustrated. In addition, the above figures assume the investor reinvested on the following day – contrary to the evidence.
Our portfolios prefer to remain invested and add value over time. Time spent on trying to time the markets is instead spent on seeking undervalued companies and adjusting portfolios accordingly. We suggest such an approach makes for a calmer assessment of opportunities and greater perspective generally.
Such an approach, importantly, also allows the full harvesting of dividends. As highlighted when addressing the Investor Chronicle investment seminar last month, it is reinvested dividends – not capital gains – that produce the vast majority of the markets’ total returns. Finding and reinvesting dividends is the key to healthy returns. And because of the effect of compounding, the longer the timescale, the greater the differential returns.
Recent analysis by Fidelity International shows that an investor who put £100 a month in the FTSE All-Share over the previous 30 years and reinvested all dividends would have produced a portfolio worth £140,585. Had the dividends been paid away as income, rather than reinvested, the portfolio would only have been worth £70,923.
And this message is not confined to the UK market. The US Dow Jones index was worth the same in real terms in 1992 as it was at its peak in 1929 – if dividends had not been reinvested – and the same in March 2009 as it was in 1966. Legendary investor Jeremy Siegal has calculated that, over a 130-year period, as much as 97 per cent of the total return from US stocks came from reinvested dividends.
Diversification and performance
However, staying invested in order to achieve financial goals need not bind a portfolio completely to the short-term vagaries of the market – quite the contrary. This is where diversification needs to be better accepted by investors as an important investment discipline. For it is often overlooked, especially in rising markets. But what is also often overlooked is that this discipline, if well executed, need not unduly harm performance
One should emphasise that very few financial assets will entirely escape a major market correction. However, adequate diversification away from equities into ‘other’ less correlated asset classes (assets that tend not to move in the same direction over the same period) as time passes will help to cushion any fall. Examples used by the portfolios include bonds, renewable energy, infrastructure, commodities, commercial property and cash.
The pace and extent of diversification will be influenced by an investor’s investment objectives, risk profile and time horizons. As time passes, investors will increasingly want to protect past gains, especially if near to achieving objectives. It is also helpful that those asset classes chosen to assist with diversification are also the ones, with the exception of cash, that are currently producing good levels of income – some of which are linked to inflation.
A real example illustrates the point well. Some context is needed. Of our website’s nine real portfolios, five represent an investment journey – these five include the two covered in this column, which are called ‘Summer’ and ‘Autumn’ on the website. This journey starts with the small all-equity portfolio called ‘LISA’ and, as the journey progresses, the five portfolios increasingly diversify away from equities into the ‘other’ asset classes mentioned above.
The journey finishes with the well-diversified and high-yielding portfolio called ‘Winter’. This portfolio has around 80 per cent of its assets invested in these ‘other’ asset classes, including a 10 per cent weighting in cash – the best ‘diversifier’ of all. Because of the high-yield nature of most of these asset classes, and the remaining 20 per cent weighting in high-yielding equities, the portfolio produces a decent level of income equating to an overall yield of 5.2 per cent.
As for performance, despite the level of diversification, ‘Winter’ has managed to keep pace with the FTSE All-Share since its inception in January 2014. Importantly, the portfolio only fell 2 per cent last year when the market fell 9.5 per cent. Its level of diversification went to work. Staying invested in an appropriate range of assets need not harm performance. Perhaps this is further evidence that the dawn has finally set on this particular stock market adage.
Otherwise, there were no changes to the portfolios during April.
