It is possible to introduce a lot of complexity into the selection of investments. Is it better to invest in large or small companies, for example? Or with this fund manager or that fund manager? Should an investor be looking at just the UK, or globally? However, for many novice investors, these decisions can seem baffling. We believe that it is possible to achieve good returns while keeping it simple.
The stock market can seem daunting to a new investor who is making their first tentative move away from a cash savings account. Some market participants make a virtue of jargon and obfuscation. In reality, novice investors can get many of the benefits of investment just by holding a diversified investment in the stock market, rather than making more complex decisions.
Investing in the stock markets has historically proved to be a good way to grow wealth over the long term. The definitive study on this is the Barclays Equity Gilt Study. It shows that over 50 years, equities have produced annualised real returns (after taking inflation into consideration) of 5.5 per cent a year. In contrast, UK government bonds (gilts) have delivered 2.5 per cent. Over 20 years, the respective figures are 4.1 per cent and 3.5 per cent. (https://wealth.barclays.com/en_gb/smartinvestor/better-investor/investing-lessons-from-114-years-of-data.html).
Investing in the stock market has also often provided better protection against inflation. It is easy to forget the corrosive effects of inflation in an environment where growth in consumer prices is near zero but over the long term, it has exerted a powerful drag on people’s savings. An investor would have needed a £10,000 investment made in 2000 to grow to £15,500 today to have the same purchasing power. (http://www.thisismoney.co.uk/money/bills/article-1633409/Historic-inflation-calculator-value-money-changed-1900.html). All it would take is some recovery in the oil price for inflation to start exerting pressure again.
In the current environment, stock market investment also produces an attractive income relative to other asset classes. The FTSE All Share currently has a dividend yield of 3.39%. This compares to just 1.88% for the 10-year gilt.
Dividends are an important source of returns from the stock market. Since 1990, those who have reinvested their dividends, would have seen their investment increase 8-fold (http://markets.ft.com/research/Markets/Tearsheets/Summary?s=FTAL:FSI), as opposed to around 3-fold for those who didn’t. Income is an often-neglected part of an investor’s overall return.
These advantages are available simply from having been invested in the market. Certainly, it may have been possible to make higher returns by investing in, say, smaller companies, or the right emerging market, but this is often difficult to predict and investors can achieve a lot of the good aspects of stock market investment without introducing that level of nuance.
However, that stock market investment needs to be diversified. This helps ensure that investors are not too exposed to individual companies. Investors also need to ensure that costs do not exert too much of a drag on their investment returns and that they are receiving the income as well as the capital growth from their investment. .
In this, we would make a case for a passive investment in the FTSE All Share. The index is naturally diversified: There are 646 companies represented in the index, diversified across 10 major sectors – oil & gas, basic materials, industrials, consumer goods, healthcare, consumer services, telecommunications, utilities, financials and technology. The largest sector – financials – makes up 26%.
The FTSE All Share is weighted by company size and therefore provides access to the UK’s largest companies, including HSBC, Royal Dutch Shell, British American Tobacco, GlaxoSmithKline and Vodafone. Many of these companies are large, global businesses and therefore an investor will also have some exposure to the fortunes of the global economy. However, a weighting in smaller and medium-sized companies also ensures that investors are not only exposed to the largest companies.
Taking stock market exposure via a FTSE All Share tracker also scores on transparency. An investor can see exactly how the index is comprised and the type of companies to which they will be exposed. There is no risk of a sudden lurch towards one sector or another. The index performance is widely available on financial websites and an investor will know that if the market rises, their investment will rise as well. This may be more reassuring to a novice investor than seeing the market rise and then having to wonder why their investment has fallen (or vice versa, of course).
Equally, using a tracker fund tends to be cheaper than using an active fund and, as mentioned above, the FTSE All Share also has a relatively high dividend yield.
There are a number of other ways investors can keep it simple. Perhaps most important is to harness the power of compounding, which is an effective means to increase returns over time. In this, it is important to stay invested: Investors who trade in and out of the market will often find their return is not as high as those investors who simply leave their investment alone. In the short-term markets are unpredictable and, in practice, investors tend to be poor at timing.
Stock market investment may seem complex to the novice investor, but there are real advantages to keeping it simple. The Aberdeen UK Tracker fund is a low cost investment trust, designed to track the income and capital return of the FTSE All Share index. We believe it is a straightforward means to achieve diversified exposure to the UK market, allowing investors to lock in many of the advantages of stock market investment without the need for complex decision-making.
The value of investments and the income from them can fall and investors may get back less than the amount invested. Please remember that past performance is not a guide to future results.
A full list of the risks applicable to this investment trust can be found in the factsheet which is available at www.aberdeenuktracker.co.uk.
