“Anybody can invest!” Right? Err, kind of. Yes, in theory any ol’ joe can be an investor, but that doesn’t mean you should go out and sink your life savings into the first investment fund you see on Seedrs.
Like anything in life, before you dive into the world of investing there are several questions you need to consider. To help you avoid the monetary equivalent of jumping into open water without checking for rocks, sharks, or pernicious hidden currents, over the coming weeks I’ll be addressing a series of important questions you should definitely know the answer to before you go anywhere near a stock market.
Let’s start with the very basics: Do markets always go up in the long term?
Now, a quick disclaimer: I’m intentionally not going to get into huge detail here or use charts or statistics, as I think this question can first be answered philosophically. But everything I’m going to discuss is and can be backed up with hard data and evidence, which we’ve discussed time and time again. If you’d like to see specifics on anything in this article, please get in touch with me at email@example.com and I’ll be happy to share it with you. Right, let’s get to it!
“Honey, I’m popping down the market to pick up some stocks!”
First, let’s all agree on what we mean by “the market”. To put it simply, we mean the Global Stock Market (GSM). The GSM is made up of pretty much all the publicly traded companies (companies whose shares you can buy on a stock exchange) across the globe. We can simplify this further; essentially the GSM consists of the great companies of the world.
All the evidence we have to date – over 100 years of market data – tells us that markets do always go up in the long term.
This comes back to one key underlying principle: new wealth can be created. There is more wealth in the world today than there was 100 years ago and there will be more wealth in the world in 100 years’ time, provided our current system of relatively free markets, trade, and enterprise endures.
New wealth is created by business (the great companies of the world). The sum of a business’ outputs is greater than the sum of its inputs. The business has taken in something, turned into something more valuable, and sold it at a profit. That’s how new wealth is created – it’s as simple as that.
Let’s take the iPhone as an example. Apple values the €Euros we give them more than the iPhone they give us. We value that same iPhone more than the cash we give them. It’s a mutually beneficial trade based on our own free will. This is the process of wealth creation.
Diversify like your wealth depends on it (it does)
Over my career, I’ve found it fascinating listening to how fundamentally this key point seems to elude fund managers, economists, and market forecasters. If they truly wanted their audience to be rational, knowledgeable, and altogether better investors, this seems like a key starting point that should be constantly reinforced and backed up with evidence. In some cases, we’ve seen fund managers claim that they are responsible for investment returns by picking the right stocks, timing the market, picking certain sectors or regions, and so on. But when the vast majority of funds managers fail to beat the market itself (it isn’t possible – stop trying!) I think a safe conclusion can be made that most investment returns come from the market and we are all just piggy-backing along for the ride.
Of course, there are a couple of important caveats to this, the main one being diversification. It’s the easy “all your eggs in one basket” analogy: you invest in one individual company, if it goes bust you’re up the creek without a paddle. If you invest in individual shares, you can lose all your money if those individual companies fail. We saw this close to home during 2008 when Anglo Irish Bank went out of business. We call this risk “Permanent Capital Loss”. Your money’s gone and it’s not coming back.
If we are invested in the Global Stock Market that means we are diversified all across the globe, in some cases investing in 10,000+ different companies. For the Global Stock Market to go to 0 would mean that every public company in the world has gone out of business. There is no market place, no one to trade with. This technically is something that could happen, but it would mean an entire breakdown of our society and civilisation (pick your favourite post-apocalyptic movie for reference here). To put it in better terms, if this did happen you’d have bigger things to worry about than how your pension is performing.
Up the mountain, down the mountain
The other big caveat here is time-frame. Everything I’ve said here is verifiable and holds water when we’re working with a time-frame of 15-20+ years. Over a 6-month period? Much less so.
Markets will always go up in the long term, but there will also be regular and often steep temporary market declines. This is known as volatility. A scary word, especially when you hear a fund manager or news reporter say it. If you’re reading this blog and are agreeing with pretty much everything I have said, you’re probably now saying “why would I care about volatility if markets always go up?”. Well, you’re right – if you’re a long-term investor, you shouldn’t care about it. Volatility is the opportunity cost for capturing the new wealth that’s being created across the globe by the great companies of the world. In fact, if you’re investing on a regular basis every month, you should be excited when the market drops temporarily, as you’ll keep buying units at a lower price each month.
It’s important to note that there are times where you do need to be concerned about market volatility.
Firstly, people who are going to need cash in the short term to pay for something they need or want. For us, short term means somewhere within 3 to 5 years. If you’re saving for a house deposit and are going to buy in 18 months, you need to leave your money somewhere accessible as you can’t guarantee markets will go up over that short of a time-frame.
Secondly, people who are making regular withdrawals from the market can be negatively affected, particularly if there is a very bad period of volatility right when they start making their withdrawals. But this is something that’s pretty easy to protect against if you engage with any decent Financial Planner, who will help you to do it smartly and efficiently.
So what do I need to do?
In summary, if you want to be a successful investor, try to follow these key steps:
- Understand that new wealth can be created and all you are trying to do is capture as much of it as you can.
- Invest regularly and embrace market volatility; it’s an opportunity for educated investors.
Focus on the long term and engage with a Financial Planner to help you understand when you need to hold cash for short-term goals.
Next time, I’ll be examining why timing the markets doesn’t work, so stay tuned to find out more. Make sure you follow us on Twitter and LinkedIn to keep up to date with our latest news and articles.
This article was written by Cian Callaghan, our Head of Financial Planning.
Metis Ireland Financial Planning Ltd t/a Metis Ireland is regulated by the Central Bank of Ireland.
All content provided in these blog posts is intended for information purposes only and should not be interpreted as financial advice. You should always engage the services of a fully qualified financial adviser before entering any financial contract. Metis Ireland Financial Planning Ltd t/a Metis Ireland will not be held responsible for any actions taken as a result of reading these blog posts.