Monday, October 13, 2008

Does long-term investing work when bourse swings wildly?

Does long-term investing work when bourse swings wildly?
By Noripah Kamso

FUND managers, me included, are forever telling investors to expect returns over the long-term. Results may vary from year to year, but over the long-term you may expect about nine per cent to 12 per cent potential returns annually.
We like to say things like: “In a bad year, the downside can be 10 per cent or more” and “In a good year the upside could be as high as 15 per cent or more”.

We also caution that risk and reward are inextricably intertwined, hence one should not expect to reap high returns without undergoing high risk and volatility.

However, we usually conclude, over the long-term it makes sense to invest in equities.

Now all that advice sounds good in theory but it’s hard to believe in it in reality when the market soars 26 per cent one year, then plunges 15 per cent another year, before swinging back up again. An investor wouldn’t be blamed for thinking, “This is madness! I don’t have the appetite for all these wild swings. What are those fund managers talking about?”

I hope, in this article, to shed some light on the issue and show that there is a method to the madness after all. Let’s look at how the stock market has performed since it started in 1976, as measured by the Kuala Lumpur Composite Index (KLCI):

Interesting points to note from this data are (See chart):

# In its 31 years of existence, the KLCI has hit the magic nine per cent to 12 per cent return range exactly once

# In seven of those years, the KLCI lost more than 10 per cent

# In 14 of those years, the KLCI gained more than 15 per cent

# Therefore, in 21 out of its 31 years of existence, the KLCI has either really disappointed investors or made them extremely happy Going by this performance, it would seem as if fund managers don’t know what they’re talking about, because the stock market has either performed outstandingly well or very poorly.

It is true that in the majority of its years, the KLCI has been pretty volatile. That’s why we advise investing over the long term, to ride out the volatility that will happen from year to year.
If investors were to analyse the numbers from 1977 until 2007, they would be surprised to learn that the KLCI enjoyed annualised returns of 9.15 per cent per annum.

Well how about that? This figure lies within the magic range of nine per cent to 12 per cent annual returns. Analysis also shows that the KLCI has registered an average yearly return of 13.33 per cent since its inception.

It is very important that investors expect returns to fluctuate widely from year-toyear, and they should probably even welcome this volatility. It is the market’s erratic journey over the long term that enables investors to get the nine per cent to 12 per cent annualised returns range. This is why a fund manager can sound like a broken record sometimes because the ending of the story doesn’t change. The important thing to realise is this: in order to get to the end of the story one must begin it, by investing.

So, when is the best time to invest? In my view, it is in the investor’s best interest to invest as much and as close to the beginning of the year as possible. In fact, I would take that year-end bonus and just invest it straight away. And I’m not saying this just because I’m in the business of managing people’s funds.

The reason is very simple and clear: in 21 out of the last 31 years, the KLCI registered a positive return. Therefore funds invested at the beginning of every year would have yielded positive returns two out of every three years, or 67 per cent of the time.

Alternatively, investors should invest regularly whenever they can, either using the ringgit-cost averaging or value averaging methods, which I will explain in detail in a later article.

In conclusion, long term investing works because it rides out stock market volatilities to give the potential returns in the nine per cent to 12 per cent range. Investors should start investing to not miss out on these potentially attractive returns.

Datuk Noripah Kamso is the chief executive of CIMB-Principal Asset Management Bhd.

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