Cotter On Investing. John Cotter
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A problem is that not many people are patient enough to take a 65-year view! However, I make no apologies for quoting such a long-term figure. Most people’s financial lives are divided into different stages. Very often they start life as a borrower, then become a saver, then an investor and end up in retirement as a spender. These financial stages are not mutually exclusive and can and do co-exist at times. However, there always tends to be a dominant theme at any one time that tends to progress in the above sequence. The investment stage in the last few decades has been extended at the front end by corporate share schemes, and at the back end by increased longevity. As life expectancy continues to grow, 65 years could soon become the average length of a person’s investment life.
As impressive as this stock market performance is on its own, compared to other types of assets it becomes even more so.
£1000 invested in the average cash deposit account over the same 65-year period would be worth approximately £61,000 today.
£1000 invested in gilts would be worth around £51,000 today. [2]
Moving on to a comparison with the fourth asset class, property, the performance of the stock market is equally impressive. It is more difficult to compare property figures because of the regional nature of the market; however, the Land Registry records show that in 1945 the average house price in the UK was £1,400, while in 2010 it was £167,000. So, a £1000 investment in the average house in the UK in 1945 would be worth £119,000 today.
So, we can see that the UK stock market over the 65-year period has produced over 19 times more than the average deposit account, over 23 times more than the average gilt, and around eight times the average UK property.
The following chart illustrates the long-term growth of the UK stock market:
Figure 1.1: FTSE All-Share Index, 1945-2011
As can be seen in the preceding chart, the stock market has generally progressed upwards since 1945. But, this progress has not been a straight line; there have been set-backs, when the market has fallen.
So, shares perform well over long periods – but what about over shorter time periods?
Shorter investing periods
The following table looks at a longer period (1899 to 2010) and compares the performance of shares against cash and gilts for every period since 1899 for a range of shorter-term investing periods:
Source: Barclays Capital
For example, let’s look at the second column of data, headed ‘3’. Since 1899, there have been 108 three-year consecutive periods (1899-1902, 1900-1903, 1901-1904 etc.). The table shows that an investment in shares for 75 of those 3-year periods would have out-performed cash. In other words, based on past performance, if you’re looking to invest over a three-year period, there’s a 69% probability that shares will out-perform cash. For the same three-year period, shares have out-performed gilts for 69 of the 108 periods, suggesting a probability for equity out-performance for any three-year period of 75%.
So, even for short investing periods, such as two or three years, based on history, equities have out-performed cash and gilts.
And as the investing period gets longer, the probability of equities out-performing cash and gilts increases.
This does not mean that cash and gilts have no part to play in your investment plan – we will see later they often do. What it does mean, however, is that shares should play a major part of any investment portfolio.
The financial case for investment in the stock market, as far as I’m concerned, is an open and shut one.
So, you’re convinced by the argument for investing in shares: should you let a professional look after your money for you or do it yourself?
Do you trust yourself or a professional?
There are five points I’d like to make here:
1. Professionals aren’t very good at investing
Many professional managers simply do not do a good job. The majority of actively managed funds under-perform the index they are seeking to out-perform.
2. Professional costs are high
The cost of professional management is significant, especially as the investment period grows. These can average between 2%-3% per annum. These create major headwinds to overcome if long-term, out-performance of the market is to be achieved.
It is hardly surprising that 80% of actively managed funds fail to beat their benchmark as quite clearly the costs mean that they would have to consistently over-perform by 2%-3% per annum simply to cover the costs and match it.
In the long-term this becomes a huge factor. For example, if you invested £100,000 over a 25-year period and achieved a 7% annual return but paid annual charges of 3%, the overall return would be approximately £266,000. If the annual charges were limited to 1%, the return would be £440,000. If no charges were deducted, the return would amount to £525,000!
Let’s put these figures in a table to really highlight them:
| Annual charge | Value of £100,000 invested |
| 3% | £266,000 |
| 1% | £440,000 |
| 0% | £525,000 |
The figures speak for themselves. Costs matter!
3. Small is beautiful
So, professional fund managers are not good at investing and are costly, but can you do better yourself? Well, investing in simple, cheap tracker funds (e.g. ETFs – more on these later) means you will out-perform the majority of professional fund managers for a start.
But there can actually be an advantage in being small. You can gain access to corners of the market that are, effectively, closed to the average managed fund due to their size. I have spoken to many professional managers who accept that a particular stock may be priced to offer value, but don’t take advantage of the situation because the amount of the stock they could purchase would be totally insignificant compared to the value of their fund.
The famous investor, Jim Slater, when speaking about the merits of small companies, said:
“Elephants don’t gallop, but fleas can jump to over two hundred times their own height.”
I believe that small can also be good when it comes to investors as well as companies!
4. Invest in what you know
Peter Lynch, the American investor, is convinced that the average investor can out-perform the professional fund manager. He popularised the concept of “Invest in what you know”, which referred to the opportunity we all have in our daily lives to spot investment opportunities long before they are identified by fund managers looking at reports and figures.
He speaks about some of the best investments he has made first coming to his notice when he was driving around with his family or shopping at a local mall.
I believed in this concept long before I even heard of Peter Lynch and I have had the same experience. In a later chapter, I will go into some