Long Term Investing Dead?

Article from Trading Tutors Newsletter.


A lot of comparisons have been made between the current Global Financial Crisis and the great depression, and indeed there are many similarities. Unfortunately though, such comparisons seem to provide little scope for optimism, especially for the longer term investor. After all, anyone who bought prior to the crash in October of 1929 would have had to wait 25 years before their capital was recovered!

Similarly long periods are quoted for more recent market crashes, such as the 1987 crash where it took 9 years for new highs to be created. So there is little reason to think that even if the market is close to the bottom, we will see a swift return to 2007 levels. But does this mean that people who were invested in the market prior to this most recent correction should abandon all hope?

The long recovery periods that are quoted assume that all your capital is invested at the absolute high of the market. For those who had been regularly contributing to their positions in the years prior to the crash, their breakeven point will be well below that of the market high. This is because a significant run up is usually seen in the lead up to a crash. In the case of the Great Depression, the Dow advanced 244% in the 5 years prior to the crash, and 54% in the year prior. An investor who had been regularly adding $1,000 to their portfolio each quarter for 5 years prior to the crash would have seen their invested capital recover in just 7 years instead of 25. This still isn’t fantastic, but it’s a significant improvement in recovery time.

Continued investment following the crash helps improve the situation further still. In the above example, had the investor continued adding $1000 each quarter, they would have seen a 42% return on invested capital over the same period. This is because we tend to see substantial gains from the low of the market. Following the low of 1932, the Dow rallied 63% in just one year. The annualized growth over the next 4 years was a massive 31%.

Professor Jeremy Siegel, a noted expert in financial markets, has conducted some interesting research in this area. He has demonstrated that for the 7 largest corrections over the past 145 years, the market showed an average improvement of 24% in the year following the crash.Moreover, he noted that there was an observed 21.4% improvement per year over the next 3 years, and 18.4% per year over the next 5 years. Clearly, it pays to invest into the markets following a large correction.

The worst thing investors could do at this point is to pull up stumps and walk away from the market. Indeed, investors should be looking to add to their portfolios, average down their entry prices and position themselves for recovery. It may well take the market 10 years to get back to 2007 levels, but that doesn’t mean you have to wait that long.


Andrew Page.

The Rule of 72

This post is written by Andrew Page from Trading Tutors Newsletter Issue #288 12 December 2008.

We all know that the share market can be a very scary place in the short term, in fact given the past 12 months we should now understand this very well indeed. But that doesn’t alter the fact that the market offers amazingly attractive returns over the long term. So as long as you can afford a longer time frame and ride out any short term volatility, your investment dollar is well placed.

With dividends reinvested, the average total investment return for the Australian market is 13.9%pa. That might not seem like much, but over time it can yield phenomenal results. This is due to the power of compounding, and although we usually associate this with savings accounts, it applies to any investment where your income returns are reinvested.

Chart 1 is the Long term performance of the Australian share market. Represented by the All Ordinaries Accumulation Index 1979 – 2008. Logarithmic Scale.

Chart 1 - click to enlarge

To gauge just how powerful compounding is we can apply what is known as the “rule of 72”. This provides a reasonable estimate of how long it takes your investment to double given a certain rate of return; all you do is divide 72 by the annual investment return. So assuming that the long term rate of return on the market stays close to 13.9%, we can expect an investment in the market to double in just over 5 years (72/13.9 = 5.18). Of course in reality, it’s not likely that you will experience a nice even rate of return from one year to the next, but over the long term it provides us with a very reasonable estimate.

To put this into dollar terms, imagine you invest $2000 into a mix of quality blue chip shares when your child is born, and you reinvest all the dividends. By the time the child reaches 21, they will be sitting on a portfolio worth over $27,000. Still not impressed? Well, what if you decided to contribute an additional $1000 per annum (that’s less than $20 per week)? Again, based on the long term historical average return of the market, your child would receive for their 21st a portfolio worth over $105,000! Furthermore, the portfolio would be generating thousands of dollars in dividends each year (not to mention the tax benefits of franking credits). It really is the gift that keeps on giving.

Chart 2 illustrates $2000 invested in 2008, with dividends reinvested and $1000 added each year. Based on an average annual return of 13.9%

Chart 2 - click to enlarge

So if you are struggling to think of presents for the children or grandchildren (or even yourself), why not consider putting some money into the market? The DividendKey program specifically focuses on building substantial wealth through conservative long term income investing, and is perfect for those wanting to generate these kinds of returns. (www.dividendkey.com)

Ask yourself what your child or grandchild would prefer for their 21st birthday - an engraved pewter, or a portfolio worth close to a hundred thousand dollars...?