Why stock market crashes don't matter

October 31, 2016

I believe financial affairs can be arranged so that no matter whether there is a massive crash or stock markets power ahead, the ability to meet longer-run financial goals will be largely unaffected.

How is this possible? The answer comes in three parts:

OWN THE WORLD

First, you need to own all or, at least, most major assets in most major regions of the world. This should include cash, bonds, property, stocks, commodities (including precious metals) and a good split between the US, Asia and Europe (including Switzerland and the UK).

The wealthiest, most financially literate people have invested like this for centuries.

In 2007-2009, the stock market more than halved, but oil hit an all-time high and gold went up nearly 20 per cent in 2009.

Sometimes Asia is on fire and sometimes America is the place to be. You'll never work out where the next 'hot' area or asset is going to be.

AUTOMATE

Secondly, you should automate your investments by direct debit each month. This achieves 'smoothing' or 'averaging in'. It removes you from the equation - which is usually a good idea.

The S&P 500 index in the US fell from 1,500 in October 2007 to the rather spooky level of 666 in March 2009 (a 56 per cent collapse. Ouch!). It then went from 666 all the way to north of 2,200 a few weeks ago and is now at 2,133 as I write (a 220 per cent recovery).

Human nature is such that if you tried to time your investments to take advantage of these moves, you would probably have got it wrong. There is a high probability you would have sold low and bought high, timing your investments badly.

Why is this? Because we are hard-wired psychologically to get this wrong. We pay a disproportionate amount of attention to what everyone else is doing. Few have the knowledge or self-confidence to be truly contrarian.

When the market bottomed at 666 in March 2009, nearly everything in the news would have stated how risky stock market investment is. As a result, you would have been unlikely to have invested in the stock market.

Even more insidious, as the market recovered from the bottom - 10 per cent up, then 20 per cent, all the way to 220 per cent - it will have been natural to say: 'Damn! I must have missed it now.'

You will then not have invested. Just as you decide to get back in, along comes the next Lehman's style crash and you get flattened, spending the next decade licking your wounds. The cycle repeats.

Take yourself out of the equation. Ignore the news and automate your investments. Don't try to second guess what is going to happen. In addition, thanks to Einstein's eighth wonder of the world - compound interest - you will end up with more money than you thought possible.

STICK TO YOUR GUNS

Finally, you must have confidence in your game plan and stick to your guns.

Professors Elroy Dimson and Paul Marsh of the London Business School have shown that investing in UK smaller companies has achieved an annual return of no less than 15.4 per cent going back to 1955! 15.4 per cent a year for 60 years!

Making that sort of return will make you wealthy rather quickly - particularly if you're using an Isa account so you don't incur any tax liability. You can literally become an Isa millionaire over the course of a few years.

Although this track record is amazing, the 15.4 per cent returns didn't come smoothly every year. Some years smaller companies powered ahead by 30 per cent or even 40 per cent. On several occasions between 1955 and the present day, however, they fell by more than 50 per cent.

These falls often cause people holding UK small caps to give up in fear, crystallise their 50 per cent loss and never invest in the space again - a terrible result and nowhere near the 15.4 per cent annual return they could be making.

Terry Smith's Fundsmith Equity fund has produced 19.8 per cent annualised returns for the last six years. Baillie Gifford's Scottish Mortgage investment trust has returned 300 per cent over the last 10 years.

By investing monthly in these sorts of assets and sticking, you can achieve consistent returns well above interest rates.

It is also crucial as you get closer to retirement. Losing £5,000 from your £10,000 pot in your 20s is an entirely different problem from losing £500,000 from your £1,000,000 pot at the age of 60. If you own the world, you won't have to worry about this.

IN SUMMARY

If you own the world, automate your investments and stick to it, you should make high single digit to low double-digit returns through the economic cycle, no matter what the latest headlines are.

Once you have done the admin needed to put this in place, you can sleep well at night and spend your precious time doing whatever you love to do, rather than waste it on following financial markets.

Andrew Craig is founder of Plain English Finance and author of How to Own the World.

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