No guarantees when you put money into shares

THE MADNESS that beset the US market on May 6 underlined how "flighty" sharemarkets can be.
After a ho-hum day, things  took a dramatic turn for the worse after lunch.
The market plunged more than 900 points in under half an hour, but then later in the day found its feet and recovered to end the day down 340 points.
What caused this fall is still being investigated but a typing error could be partly to blame. Urban legend has it that a dealer mistakenly hit the "b" for billions key rather than the "m" for millions, sending out a far larger sell order  than  intended.
More concerning was the panic-selling this "fat finger" error seemed to cause. Automatic computer models were sent into  overdrive and many hedge funds and traders who use these systems sent a wave of sell orders  around the world.
Investing in shares  involves  uncertainty. Optimists might call this excitement. I prefer to call it uncertainty.
Sometimes markets react rationally to news, but at others  behave  irrationally. The widespread use of computer systems only adds to this mindless volatility. Pun intended.
Some outfits in New York have  moved offices so they could be a few blocks closer to the stock exchange in the hope the smaller distance meant their computers  got market-price data a nanosecond quicker and gave them an edge over their rivals.   Madness.
Returns from shares are unpredictable and volatile. I know that sounds like a stockbroker shooting himself in the foot, but trying to convince people to buy shares because they offer any  certainty in terms of future returns is simply false advertising.
It is true that shares offer the highest potential returns, but people should not invest in shares under any misconception that these returns are certain.
Borrowing an idea from Marcus Padley, a Sydney Morning Herald market commentator  who recently looked at historical returns from Australian shares, I did a quick exercise and looked at the returns from a share portfolio since 1990.
I used index data and put together a portfolio made up of 40 per cent New Zealand shares, 30 per cent Australian and 30 per cent US.
Since 1990 this portfolio has delivered a compound average annual return of 8.2 per cent.
The portfolio lost money in one of our every four 12-month periods.
When it fell, the average loss was 11 per cent and when it rose, the average gain was 16 per cent.
The best 12-month return was in 1993 when the portfolio rose 40 per cent. The biggest fall was during the global financial crisis in 2008 when it fell 31 per cent.
As Padley pointed out,  expecting any form of "average" return from shares is ridiculous when you consider that next year, based on the returns from the past 20 years, returns could be anywhere from plus 40 per cent to minus 31. 
As if to highlight the point, only one 12-month period, out of this sample of 230 such periods, delivered a return that matched the average return of 8.2 per cent.
The returns were more volatile, and gains and losses more extreme if you invested in only one market, but I included three together because investing in only one market is so laced with danger that it is not something  to  contemplate.
Even with diversification, returns from shares are  volatile. This reality makes the market forecasts that we all do of limited value. Nobody knows how the market will perform in future.
For those not liking the sound of the uncertainty that comes with investing in shares, the alternative strategy is to shun shares in favour of the certainty that comes from investing in fixed income. But  returns are lower.
After a quick scan of websites, it is  clear  you can get rates of about 5.5 per cent from banks at the moment - a  good rate considering the Official Cash Rate is just 2.5 per cent.
However, if we take off tax at 30 per cent we are left with a net return of 3.8 per cent. Then we need to consider inflation. We are forecasting inflation to increase. If we assume a CPI of 2.5 per cent, taking this away from the net return leaves a real return of 1.3 per cent a year.
By comparison, the 8.2 per cent gross return from shares, after deducting tax on dividends of 1.1 per cent and inflation of 2. per cent, leaves a net real return of 4.6 per cent.
What about that other alternative to shares - property? It's a good investment, but only for those who understand that the expectation of property delivering "10 per cent a year, every year" is  unrealistic.
Although returns from property are slightly more reliable than those from shares, they are still volatile.
As the past week has shown, investing in shares is full of uncertainty and involves risk. And while fixed income offers certainty, returns are lower. Property is less volatile than shares, but returns are still uncertain.
Nobody said investing was easy; and the moment it feels easy, get worried.
Cameron Watson is director, private wealth research at Craigs Investment Partners, based in Tauranga. His disclosure statement is available free  under his profile on: www.craigsip.com. This column is general in nature and should not be regarded as specific investment advice.