Pillows are silly places to tuck nest-eggs

By MARY HOLM

Q: I am one of the converted who invests in a diversified portfolio of international shares (and sometimes a mix of bonds), riding out short-term volatility in the belief that the long-term benefits from shares exceed other forms of investments.

Imagine my surprise to learn from your professional colleague Brent Sheather that, in the future, shares will produce lower returns than bonds!

He relies on research by two American academics, Robert Arnott and Peter Bernstein, who say that superior returns on shares as compared with bonds over the past 75 years were not "normal", but that we can now expect normal (pre-1925, presumably) service to be resumed.

If that were correct, then presumably any well-advised investor would place all his portfolio in bonds or property or other assets. But if that were to happen on a global scale then industry would grind to a halt, wealth and capital would disappear and there would be wholesale default on redemption of bonds.

Should I cash in my investments and put the money under my pillow?

A: Keep your pillow for sleeping on.

How much more you can expect to get from investing in shares rather than bonds - called the "equity risk premium" because it's a premium you get for taking on a higher-risk equity investment - is a hot topic.

Arnott and Bernstein have said that the equity risk premium is zero. They say we should expect much the same average return on shares and bonds.

But many top researchers disagree.

At a recent US conference of the Association for Investment Management and Research, experts came up with equity risk premiums ranging from zero to 5 per cent.

Pretty much everyone does agree, though, that the equity risk premium will be lower than in the past. There are several reasons for this, among them:

* As the Baby Boomers enter middle age and start serious retirement saving, there have been huge increases in cash inflows into share investments. And this will continue for another decade or so. Just as higher demand for apples pushes up prices, so it does for shares, whose prices are higher than they would have been without the Boomers. Higher entry prices mean lower returns, everything else being equal.

* Transaction costs on shares - brokerage, fees and so on - have fallen. Share investors don't need to make so much extra to cover those costs.

* It is now easier to diversify share investments, through managed funds. This reduces the risk of share investment, and so reduces the reward for taking on the risk.

The Baby Boomer effect is just something we have to live with. The other two reasons are easy to accept. If share investment is cheaper and less risky, we should be happy to receive less of a margin for going into shares.

For all that, though, I can't imagine the risk premium going even close to zero.

Consider this: If lots of followers of Arnott and Bernstein bailed out of shares, prices would fall.

But the companies whose share prices had dropped would continue to do business and generate earnings.

With lower share prices relative to earnings, expected returns to new investors would grow.

Increasingly, the returns would be high enough to reward investors for buying shares rather than bonds. They would view the shares as bargains, and be keen to buy.

Because of the way markets work, your scary scenario, of everyone getting out of shares, simply wouldn't happen.

I'm still backing shares for the long term.

* * *

Q: A simple piece of advice for those people who have seen their shares fall in value: hold on.

When property values fall, do these people think, "Oh my God, I've got to sell my house!"? Most likely not.

Why not apply the same thinking, and just sit tight.

This of course does not apply if there is reason to believe that the company you are invested in is going to fail, however. But usually this would not be the case.

A: Well put. I, too, have been saying, "Hold on" for months now. But I haven't made the comparison with house values. And it's a good one.

Property values probably fluctuate much more than people realise. If you auctioned your house daily - with an unrealistically high reserve price so that the house kept being passed in - you would probably be shocked at the variation, over the months and years, in top bids.

While share prices are there, in the paper, for everyone to see, we are often blissfully ignorant about property price fluctuations.

Sometimes, though, house values fall enough for everyone to be aware. Yet, as you say, the last thing most owners want to do is sell in a down market. And the same would probably apply to rental property.

The difference, I suppose, is that people have faith that property values will rise again. Apparently some are not so sure about share prices.

As you say, that apprehension is fair enough about companies that are not doing well.

That's why I think most people are better off investing in share funds, which hold shares in many companies. While a few of those companies may go down the gurgler, others won't.

You can be pretty sure that the value of a share fund investment will recover from a plunge if you stay invested for 10 years or more.

Meantime, try to regard the market ups and downs in the same way as you regard real estate ups and downs.

* * *

Q: My concern relates to my unit trust superannuation fund.

I've got a dynamic portfolio with WestpacTrust and have been paying a little over $200 a fortnight for seven years. (I'm married with grown-up children, 48, only a very small mortgage.)

As you can imagine I look at the weekly newspaper spread sheets on returns with some despair as I watch my funds return minus 19 per cent (the worst return to date).

I understand the principle of being in for the long haul and accept that I don't need those funds for 15 or so years, but I'm getting nervous.

I was rash leading up to the 1987 crash and took a savage financial hit. I've been conservative ever since, but do wonder whether I should cut back on the super scheme and stick with term deposit investments.

A: I hope, after reading today's first two items, that you're feeling braver.

Perhaps you should stop looking at your returns on a weekly basis. As I said above, you don't do that for your house.

There's such a thing as too much vigilance when it comes to investments.

Your nervousness, no doubt, stems partly from your 1987 experience. But, if you took a "savage hit" then, I suspect you weren't very well diversified - and possibly also borrowed to buy shares, which pushes up the risk.

You are now investing in quite a different way.

Your super fund holds about 25 per cent cash and bonds and the rest shares and property. More than half is in international shares. So you're in several different types of assets, and many different shares.

If you had held that sort of portfolio in early 1987, and reinvested your dividends, your investment would now be worth two or three times what it was then, despite the Crash and recent downturns.

Still not comforted? If you really can't cope with what's happened lately, consider switching some of your money to one of WestpacTrust's less-risky super funds. You can do that for no fees.

Going to term deposits is too extreme. They'll give you non-volatile returns. But the returns will almost certainly be lower than on any of the super funds.

With 15 more years to go, I'd like to see you stick with what you've got. I would be amazed if you're not glad by retirement.

* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or email: maryh@pl.net. Letters should not exceed 200 words.