It is an age-old question, as old as the city of Babylon itself. How might I put my surplus money to work? Fortunately, rather than giving our surplus funds to a dubious door to door money lender in the hope of earning interest, we now have multiple avenues to place our funds and a wealth of datasets on these at the palm of our hands.
The question of where these surplus funds should go, however, is easy: Stocks. Understood by a few interchangeable names, shares, equities, and stocks, are simply ownership in a particular company that trade on a public exchange. Although many understand these as simply a piece of speculative paper, the underlying ownership that this paper represents has a very real and tangible value. Own enough of these scraps of paper, and you call the shots!
The regular and sometimes erratic oscillations in the market price of equities can reinforce the speculative notion, however humans are the main flaw in this mix, by their nature they are emotional and prone to error, even the most equipped investors can exercise poor judgment in certain circumstances. In turn, these emotional beings play their role in the never-ending battle for prices to find their balance where there is a constant collision of investor expectations of the future.
Many people’s perceptions of the stock market have been soured by the occasional crash in the market, most remember the painful episode of 2008, and even more fresh in the collective conscience sits the dramatic fall when the Covid 19 pandemic began. But despite the perceptions and in-built volatility, no asset class is more powerful at putting savers money to work than equities.
One of the most valuable datasets on this comes from Aswath Damodaran of NYU, who compiles annual returns for stocks, bonds, and bills in the US. As this resource is updated yearly, it offers a wonderful insight into the power of equities and with the US being the poster child for the power of equities in wealth building, it is the most pertinent place to begin.
Rightly earning its title, $100 invested across US equities at the beginning of 1928 with dividends reinvested would be worth $592,868.15 at the end of 2020 representing a yearly return of 9.79%. And even when taking into account the effect of inflation, the real return is 6.83%.
When compared with the UK the returns on equities were less impressive but are nonetheless compelling. According to Elroy Dimson, Paul Marsh and Mike Staunton at the London Business School, UK stock market returns still reached 9.1% from 1900-2020 in nominal terms, however only 5.4% after adjusting for inflation which was markedly higher than the US.
When considering the 20.74% price return on the S&P 500 and the 9.84% price return on the FTSE 100 so far this year, we may be inclined to think that these returns seem rather meagre. However, this is not the case, the consistent accumulation and application of compound interest over the period ensures that the initial sums invested eventually grow exponentially. As Albert Einstein would say, compound interest is the most powerful force in the universe.
It is however, only when comparing these returns to other asset classes we begin to really get a sense of the power of equities. When considering bond returns over the 1928-2020 period in the US, these are 6.9% for Investment grade bonds, 4.9% for 30-year governments bonds and lower for governments treasury bills at 3.3%. Yet again lower after inflation, with a meagre 3.9% for Corporate Bonds, 1.9% for 30-year governments bonds and 0.3% for Bills. A similar story is seen in the UK, with equities taking a decisive lead over the period.
The returns on property are also surprisingly disappointing over a similar period. From 1900-2017, the real price of domestic housing in the US has only grown 0.3% per annum. A widely loved investment due to the nature of bricks and mortar, this return shows how government bills in the US were just as good at increasing purchasing power.
UK domestic housing fared far better, though this perhaps has something to do with the finite space and significantly higher population density we have here in the United Kingdom. With a real price return of 1.8% per annum over the same period. Of course, these figures do not account for the rental income earnt, however, it is rather difficult to reinvest rental earnings in property by virtue of the values they require.
Now property, bonds, and bills appear disappointing in comparison, but this isn’t to say that they have no place within a portfolio or that there may not be sub-periods where one asset class may outperform the other. A situation which we are currently seeing in the UK and have been seeing for some time. For example, since January 2015 the governments House Price Index has almost outperformed the UK All-share by double. With the index growing 33.5% versus 18.3% for the UK All-share.
Although this trend doesn’t bode well for UK equities at the moment, exposure to foreign equity markets has never been easier in our ever more connected world. Exposure to the top 500 US stocks via the S&P 500 over the same period would have seen a return of over 100% within the same period.
Therefore, we needn’t be saddled with only UK exposure, but the trends are clear. Given a long enough period, it can reasonably be expected that equities will outperform other asset classes, even in the current lacklustre UK market.
Dimson, E., and Marsh, P., and Staunton, M.,
2021. Credit Suisse Global Investment Returns
Yearbook 2020. Zurich: Credit Suisse Research
Dimson, E., and Marsh, P., and Staunton, M.,
2018. Credit Suisse Global Investment Returns
Yearbook 2018. Zurich: Credit Suisse Research