For the uninitiated, equities – shares in stock market traded companies – represent the best performing investments in the long term. History shows that, despite sporadic periods of volatility, they consistently deliver an average 6 per cent return. However, these periods of volatility can be quite dramatic, with small investors vulnerable to severe shocks in the moment.
Attitude is therefore key when it comes to equity investing, says Ian Quigley, head of investment strategy at RBC Brewin Dolphin. “It requires patience and a long-term mindset, and it is important that investors appreciate this at the outset.”
Although volatility also poses a challenge for even long-term investors, Quigley says it is important to recognise that the additional return investors will likely earn from investing in equities, compared with alternatives like bonds and cash, can be considered a “form of compensation” for occasional periods of market decline and any discomfort they can cause. “It is common for equity markets to experience double digit declines and thus it is important that investors approach investing with a long-term time horizon, allowing time to recover from setbacks,” he says.
Risk questionnaires are therefore essential when it comes to building the most appropriate portfolio for any investor. Quigley says all RBC Brewin clients are asked to complete a risk questionnaire before an investment mandate is agreed.
“Time should be taken to understand what we are looking to achieve, with realistic expectations,” he explains. “Once we have completed this process, we build a portfolio that we believe can deliver reasonable returns, combining more volatile assets like equities with historically less volatile assets like government bonds. There will always be a trade-off between risk and return, and we encourage a frank conversation about what can be achieved, and the potential volatility clients may experience in their portfolio.”
What about those who are keen to begin dabbling in equities trading? “The simplest and often most effective way is to simply invest in the world equity market index, via an index fund or exchange traded fund (ETF),” Quigley explains. Other options include investing in actively managed funds or investing in a portfolio of stocks, but he points out that tax should also be a consideration. “Investors should seek to understand the tax treatment of assets too.”
But again, it comes back to patience – these are not get-rich-quick schemes. “All equity investing should be long-term investing, whether that is for funding education or retirement,” Quigley advises. “We encourage clients to invest for at least five years, and, in practice, time horizons extend into decades.”
Karl Rogers is managing director and chief investment officer with wealth management firm Elkstone. He says playing the stock market for short-term financial goals is akin to doing the lottery; it is the investor whose time frame can be measured in decades who will ultimately do best.
“If your time frame is long term, for goals such as your children’s future college funds or your own retirement, equities are a great investment which benefits off the eighth wonder of the world: compounding,” he says.
When it comes to stocks, price fluctuations are driven by market participants taking views on the performance of the company and reacting to short-term news, Rogers says. “The fundamentals of the companies do not change frequently,” he adds. “The company creates value through increasing revenue and profit margins – it’s worth remembering this during quick negative price fluctuations.”
Company value creation takes time too. “Venture capital underwrites for this fundamental value creation process to take between six and 10 years, while private equity buyout underwrites a five-year time frame,” says Rogers. “While the price of the stock directly leads to the profit and loss in your brokerage account, what you are investing in is the company’s ability to create value. As this is a long-term process, equities should be seen as long-term holdings, ignoring the short-term price fluctuations which are driven by market participant speculation.”
Rogers thus advises a hands-off approach – indeed, he suggests the best thing for equity investors is to “sit on their hands”.
“The frequency at which you look at your portfolio is crucial to long-term benefits. The less frequently you view your portfolio, the more you will stick to your game plan and observe the benefits of such. The practice of looking at your portfolio during the day, each day or even each month will lead to negative results.”