The Benefits of Regular Investing
March 2007
Summary: Dr. Clare Mc Andrew looks at how regular investing can help smooth out the ups and downs of the stockmarket over time.
March has been a very turbulent month on equity markets, with indices around the world dipping significantly in a series of market disturbances that has sent a wave of panic through much of the international investment community. Referred to as the 'big sell-off', the major volatility in equity markets began at the end of February, and as is often the case with disruptions such as these, the media frenzy that has surrounded the markets since has been intense. Coverage in Ireland, as elsewhere, has been unnerving for many, and arguably as disruptive as some of the underlying triggers in creating self-fulfilling downward spirals in some investor's portfolios. We take a temporary break therefore this month from our journey through the fund's prospectus, to try and put some of these recent events into perspective.
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What Went Wrong?
The turbulence in global equities markets during the last fortnight has been driven by a number of triggers. Many indices fell sharply at the start of the month in the wake of a steep sell-off in the Chinese market, caused mainly by fears of a series of regulatory and tax changes by Chinese authorities that might affect their equity markets. Although these turned out to be unfounded for now, the Chinese actions were thought to have been a spark that fuelled some more deep rooted fears in the international trading community about the position of the US and the outlook for world growth. For the last number of weeks, the spotlight has been on growing problems in the US sub-prime mortgage lending sector, alongside some more general pessimism about US economic prospects, following the release of a string of poor results and indicators. Comments from ex Fed Chairman Alan Greenspan suggesting that it was possible that the US economy would experience a recession before 2007 was out certainly didn't help, and added to the general feeling of global economic uncertainty as commentators started to bounce ideas off one another. Worries were also amplified when the Yen kept appreciating this month against the US dollar, which was thought to be a sign by many analysts that 'carry trades' were being unwound. (Carry trades are simply where investors borrow funds in countries such as Japan where interest rates are low, and invest them in countries where the proceeds are higher.)
When the market, driven by triggers such as these, is uncertain or pessimistic in its outlook, the reaction of many investors at the 'front of the pack' is to move into the relative safe havens of bonds or other low risk/ low return assets. This movement out of one set of equities causes their related equity indices to fall, and this in turn sets off jitters through other equity markets, more people sell out, indices drop some more, and so the vicious cycle extends. The 'herd mentality' in stock markets that often causes a dip in the market to turn into a more serious and seemingly 'unjustified' decline is well documented, and has often magnified the effects of real events and announcements in the economy.
Doom or Just Part of Boom?
The ISEQ Index has fallen considerably in recent weeks. Measuring from a recent high around the 20th of February to its lowest most recent point (on the 5th of March), the index fell by nearly 9%. Figure 1 below shows clearly that the last two months has shown classic volatility, with a series of peaks and declines over the period. After some improvement, a further dip around the 13th of March caused renewed distress among many Irish investors, with some of the media posting glib warnings of impending doom for equity markets. Some reports in the Irish press have even gone so far as to predict big losses for those equity- based SSIA holders due for maturation in April. While it is clear that the value of some portfolios of equities have (temporarily) declined, those SSIA holders who chose to proactively invest rather than letting their money sit in deposit accounts are still undoubtedly going to come out on top. Equity SSIAs are still worth more than the deposit-based SSIA accounts (assuming maximum investment over the period), and while the negative slumps on the stock markets may reduce some of the windfalls, the results are unlikely to be severe.
It is important to remember here that although the Irish markets have fallen in recent weeks, and fallen more than the European average, much of this was driven by the relatively good start they made compared to other markets in recent years. Taking a wider view, more confident market-watchers argue that in fact recent sell-offs globally are no more than a healthy correction, inevitable after almost four years of constantly rising global asset prices.
That said, it is equally important that equity market declines around the world of this magnitude are not just dismissed or even taken lightly. What is crucial though, is that investors try to maintain a long-term perspective and not fall into making poor future investment decisions driven by panic or media hyperbole. Either way, the key to successful equity investing is making investments on a regular basis.
The Benefits of Regular Investing
Investing in equities always involves some degree of risk, as markets can be volatile and cyclical. However, looking at the bigger picture, the equity market has proved time and again that, given an investor has an appropriate long term horizon and can wade out the down turns, investing in stock markets can be profitable and rewarding. Figure 2 also shows the ISEQ Index, but this time with a wider three-year time horizon, which presents a much more positive view than the previous snapshot.
Some more active investors and speculators look at the volatility in the market as opening up a range of buying opportunities that didn't previously exist, and will try to profit on short term movements. For most of us however, a safer and more regular strategy that will see us through the ups and the downs, may be more in line with long-term goals.
A simple and effective option for maturing SSIA holders therefore is to set about involving themselves in some form of regular equity investment schedule. The choice of which fund or plan to be involved in is down to the individual, and should be based on careful research and weighing up of the costs, benefits, risks and suitability. The key to embarking on any regular investing plan however is to abandon any strategy that might try to control the timing of your investments, and continue to invest irrespective of market conditions, just as so many SSIA savers have been doing to date. The strategy of regular investing works very well partly because of averaging and partly because in the long run markets move upwards, in spite of short-term falls. Over the last few decades, international equity markets have been remarkably resilient, absorbing an unrelenting series of large and small disturbances. Most volatility is relatively short term and over the medium term most industrialised economies are very stable. This stability is not accidental - it comes partly from having built instruments, institutions and markets that efficiently allocate risk, and also ( with some exceptions) having financial and monetary policy makers that understand what they are doing and take a long-term macro view. Many astute investors will already have some form of a lump sum in an investment scheme or fund, and this is commendable, but should not be the end of the story. To significantly build wealth over time, this needs to be followed by regular investments as and when investible surplus becomes available.
One final critical word of advice to newly maturing SSIA-holders looking for options with their newly acquired lump sum, what absolutely not to do, is to leave it sitting in the bank. Regular investing in whatever scheme, fund or products you chose will always be a more profitable strategy than having your money sit in a low rate deposit account. Not only do deposit accounts offer little in the way of value with most offering little or no interest, they also give you easy access to money that you were previously saving which even the most prudent person can be prone to wither away. According to recent figures from the Central Bank, there is already over €70b sitting in deposit accounts in Ireland, which is not creating wealth or offering little real value for the people it belongs to. Bank accounts of course serve an important function in providing a safe place to access cash and pay bills, but besides working more (and few of us want to do that even if we could), the only other way you are going to actually create wealth is through investing.
Figure 1. The ISEQ Index from February to March 2007
Figure 2. The ISEQ Index from 2004 to Present
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