This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, James Dilworth, CEO Allianz Global Investors Europe considers whether equities are the new safe option for portfolios.
When reading the headlines about new highs in share prices, don’t you find yourself wishing you had invested more, or even invested at all? You’re probably not alone. As a rule, investors are averse to losses and tend not to act in a purely rational manner. Increasing losses weigh more heavily than additional earnings, and many were burned in the crises witnessed so far in this young century as stock market losses reached nearly 50%. As a result, many investors have closed their eyes and are blind to the long-term growth story behind equity investments: that equities can offer more safety over an investment period of 30 years than top-rated government bonds.
The long-term success of equity investments isn‘t actually that surprising. A look at the foundations – real macroeconomic growth – reveals that mass prosperity has grown enormously over the last 200 years, especially in industrialised countries. Measured in terms of real gross national product adjusted for inflation, industrialised countries such as the USA, UK or France have seen average growth of 3%, 4% and 3% a year, and the emerging markets around 4% a year since 1800.
In the past, shareholders have for the most part benefited from this prosperity as their stocks represent a fraction of equity capital that allows them to participate in the productive assets of a company or, at macroeconomic level, of a country – and there are very few other investments that offer the same opportunity. After all, long-term economic growth usually goes hand in hand with earnings growth, irrespective of whether the latter stems from increased sales or more efficient deployment of labour and/or capital, or whether revenue is generated at home or abroad. Shareholders benefit, provided they hold shares in successful companies.
A look back into the past in the USA – for which the longest historical time series is available but whose lessons learned are, in many cases, equally valid for other regions – shows that company earnings have increased nominally by about 4% a year since 1871 in spite of numerous deep recessions. As US company earnings increased over the past 213 years, so did equity prices on the US stock market. Between January 1 1871 and December 31 2013, the S&P 500 index rose from 4.44 to 1,843 points, equivalent to an increase of about 4.3% every year on average. Adding in the contribution from reinvested dividends – which yielded about 4.4% on average and accounted for a good half of all performance – translates into a total return of more than 800,000 index points, equivalent to historical growth of 8.7% every year in the S&P 500. If our great-great-great-grandparents had invested $100 in an equity portfolio back then, the heirs of today would hold assets worth about $15 million.
Risk cannot be eliminated, but it can be managed. The longer the investment horizon, the less important the timing for investing in equities seems to be. For example, someone who let his savings work for him over a period of five years would have suffered a loss in thirty-six cases over that period during the last 213 years, compared with just sixteen cases over a rolling 10-year period.
Over the long term, and bearing in mind that inflation will eat away at purchasing power, the biggest risk facing investors who want to preserve or increase their wealth lies in not taking any risks. As far as investments in fixed deposits and top-rated government bonds are concerned, this risk will probably strengthen rather than lessen in the current environment of low interest rates and in light of the long-term expectation of rising interest rates and the threat of price losses. By contrast, real assets, such as equities, have a good chance of continuing their historical success, given that the long-term risk premium expectations still appear attractive. Accordingly, investors should venture beyond the current uncertainty when deciding their strategic (long-term) asset allocation and be aware that we are possibly already in the midst of a golden era for equities.
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