We hear the phrase all the time: "Invest over the long term! Don't punt in the stock market!" Is that really a wise investment?
THE CHANCE FOR A POSITIVE RETURN IS HIGHER
We
started with a familiar market again - the Straits Times Index. Our
period: 25 years starting from the year 1976 and ending in the year
2000. This period included the 1979 Oil Shock, the 1986 Singapore
recession, the 1997 Asian Currency crisis, and other world events
which had an impact to a certain degree on Singapore, which is so
exposed to external influences.
We first took a tally of all the
positive growth periods in the Straits Times Index on a 1-year basis.
There were 15 out of 25 years in which the Straits Times Index had
positive growth. This means that if you had randomly picked the start
of any year from 1976 to 2000 to buy into the Straits Times Index and
you had a holding period of 1 year, you would have had a 60% chance of
coming out ahead.
We then tried the same experiment on a
holding period of 3 years. The result was that out of twenty-three
3-year periods, eighteen of these were gains. So, if you had invested
in the Straits Times Index at the start of any year from 1976 to 2000
with a time horizon of 3 years, you would have had a 78.26% chance of
coming out ahead (quite a large improvement over 60% isn't it?).
We also experimented with 5 and 10-year holding periods. Take a look at the results in the following chart.
Chart 1
Source: S&P Micropal
As
you can see, when you extend the holding period to 10 years, there is a
100% chance that you would have made money. The question now is, does
this apply only to the Singapore stock market? What if we were to try
the same experiment on other stock markets? Well, we did, on six
other stock markets:
USA (represented by S&P 500)
Technology (represented by NASDAQ)
Europe (represented by MSCI Europe)
Taiwan (represented by the Taiwan Weighted Index)
Hong Kong (represented by Hang Seng)
Japan (represented by the Nikkei 225 Index)
World (represented by the MSCI World USD)
Chart 2
Source: S&P Micropal
LONGER HOLDING PERIODS BETTER
As
can be seen, the increasing percentages of positive periods for all the
stock markets would seem to suggest that, at least historically, the
longer your holding period, the greater the possibility of making
money from an investment in one of the above equity markets.
In fact,
in six of the markets shown above, you would have made money 100% of
the time if your holding period were 10 years.
At this point,
some may ask: "I can come out just 5% ahead after holding a Singapore
fund for 10 years. That is a far cry from the 21.89% I would gain even
if I were to keep it in a fixed deposit giving me 2% per annum!" That
could be the case. After all, investing in equity markets are always
riskier than investing in fixed income instruments.
So, we now choose
to be more strict in our analysis. Instead of just having a positive
gain, we choose to take the periods where the annualised gain (or
average gain per year) is more than 4%. This is pretty reasonable
since even the CPF special account can only promise 4% per year.
If
an investment grew by 4% per year, after 3 years, it would have grown
12.49%. After 5 years, it would have grown 21.67%, and after 10 years,
it would have grown 48%. This is because of the miracle of
compounding (we won't go into that today as that isn't the focus of
our study).
WHAT IF WE USE A STRICTER CRITERION
We
also analysed the Straits Times Index with a stricter criterion. We
counted periods where the returns were over 4% per year, over 12.5%
for 3 years and more, over 22% for 5 years and more, and over 48% for 5
years and above. These would then be counted as a percentage against
the total possible 1-year, 3-year, 5-year and 10-year periods over the
last 25 years. The results are shown in Chart 3.
Once again,
you can see that the rising trend over longer holding periods does not
change. Also, even taking into account that our criterion is now far
stricter, when you extend the holding period to 10 years, the
probability that you would have gained a compounded 4% per year was
93.75%. Thirteen out of fifteen 10-year periods saw a gain of more
than 93.75%, where the Singapore Straits Times index was concerned.
Just as with our initial analysis, we extended this to cover the six
stock markets and the world index mentioned in Chart 2. The results
are shown in Chart 4.
Charts 3 and 4
Source: S&P Micropal
SAME TREND IN OTHER STOCK MARKETS
The
same rising trend can be seen for every stock market that we measured.
For six of these stock markets, there was a higher than 90%
probability that if you had invested in the stock market index at the
beginning of any year since 1976, with a 10-year horizon, you would
have made better than 4% per year. If you wanted to time the markets
(meaning that you jumped into a market with all your money, then
jumped out again after 1 year to hop into another market), then from a
statistical point of view, your chances of making better than 4% per
year would be significantly less and your transaction costs would be
higher as well. We did not try to see if a shorter holding period of 6
months or less would give better results - we suspect that they
won't.
One more interesting conclusion you might arrive from
looking at Charts 4 and 2 is that the US stock market represented by
the S&P 500 Index is a less volatile stock market than others. It
had a 100% probability of having a 5-year gain, and also has one of
the highest probabilities of having an average compounded 4% gain over
the various periods measured. We believe that this is due to its low
reliance on external fund flows. Most of the capital that make up the
stocks in the US market are from US investors. Even during downtrends,
US investors are not outward looking preferring to hold cash, or
shift to bonds. This results in a more stable market environment where
there are fewer drops, or spikes. As we mentioned in our previous
article "Do Top Performing Markets Always Shine," there are times when
other stock markets may outperform the US stock market. However,
these stock markets may also be more volatile.
LIMITATIONS
These
analyses are statistical in nature and have their underlying
limitations. The two main limitations would be analysing past
performance data (which are not a guarantee for future returns), and
not taking into account transaction costs.
Nevertheless, this is
balanced by two considerations. Regarding the limitation of looking at
past data, the figures taken were from an extremely long period of 25
years, during which there were quite a few wars (especially in Middle
East), there was a global oil shock, and recession. So, if you are a
believer that history repeats itself, then you will also come to the
same conclusion: Long-term investing works far better than short-term
punting.
The limitation of transaction costs is balanced by the
fact that we were measuring only the indices and not active funds that
invested in these markets (most of the funds in Singapore do not have
such long histories). If you choose a good fund manager, one that is
able to outperform the market index he invests in over the long run,
you will not only be able to cover any possible transaction costs, you
may even have gains better than the market index.
In conclusion,
we first state that our objective here was not to find the best stock
market to invest in. We recognise that each stock market has its
peculiarities, and some have historically been more volatile than
others. However, based on our analyses, we can at least discover a
common trend among stock markets regardless of their size, volatility
and other attributes. This common trend is: Long-term investing has a
higher statistical chance of giving returns than short term investing.
