Eight lessons from the past

1: There is nothing particularly unusual about the recent fall in share prices. Declines of this size and duration have happened in the past with regular frequency and will do so in future.

2: The period from 1987 to 2001 was an unusually long one without a major fall in sharemarkets. This may have left investors complacent about the risk of investing in shares.

Based on past experience, shares can be expected to produce a negative return about one year in three. A severe shakeout, such as this one, has historically happened every five to 10 years.

3: This does NOT mean we shouldn't invest in equity markets, merely that they are volatile. It is reasonable to expect the return on shares to exceed the return on fixed interest by about 3 per cent a year. Over 10 years the return on shares should be around 50 per cent higher.

Shares should remain a significant portion of long-term investors' portfolios.

4: Reacting to market falls by withdrawing funds is fatal, as is plunging in whenever markets have risen. This is largely because markets tend to revert to average returns. The strongest sharemarket returns are often experienced immediately following significant falls.

5: Investors everywhere are prone to investing with hindsight. Inflows to investment markets surge in response to high returns, and vice versa. Over longer periods this conceivably reduces returns by a half, possibly more. Most investors would be far better served by not trying to time markets.

6: Near-term prospects for sharemarkets are improving. The major markets are at their cheapest levels for several years. Monetary policy has turned stimulative and earnings estimates have now been heavily discounted. By contrast, fixed-interest prospects look poor, as they have done after previous crises. The New Zealand dollar has strengthened recently but it has limited room to rise.

7: The benefits of diversification are as apparent as ever. Speculators in tech stocks have seen their investments fall almost 70 per cent since early 2000. Broad sharemarkets have fallen only one-third of this amount.

In contrast, returns from other asset classes have been strong. New Zealand shares are up 8 per cent so far this year. Local and global fixed-interest returns have been in the 10-12 per cent range for the 12 months to August. These gains should mean that balanced-fund investors have essentially maintained their capital values. This is not a bad result considering how much those asset values had benefited from the preceding five years of bull markets.

8: Possibly the greatest damage from episodes like this is not to asset values, but rather to investors' confidence and to their investment strategy. It is imperative that investors choose an approach they are comfortable with and stick to it through thick and thin.