The Attraction of Equities
Asset Classes
The principal components of an investment portfolio are equities, bonds, property and deposits. While the objective for the investor is to optimise returns from all of these asset classes, it is important to realise that each offers a distinct trade-off between risk and return.
Equities - The Long-Term Winner
Historically, shares have proved to be the clear winner over the long term. For the patient investor (i.e. with a time horizon of five years and upwards), equities have outperformed all alternate assets. To illustrate, consider Graph 1a, which highlights the various returns from placing €1,270 in each of the investment alternatives over the five years to 1998. If equities were your preferred choice you would have earned a 205% return, compared to 171% for property, 55% for bonds and 33% for deposits. Likewise, as Graph 1b shows, if you made a similar investment in equities in 1978, twenty years later your capital would have been worth approximately twice what it would have been worth if you had invested in property or bonds and almost four times what it would have been worth if you had invested in deposits.
| Graph 1a |
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Graph 1a: 1998 value (nominal terms) of €1,270 invested in 1993 |
| Graph 1b |
Graph 1b: 1998 value (nominal terms) of €1,270 invested in 1978 |
| Graph 1c |
Graph 1c: 1998 value (nominal terms) of €1,270 invested in 1978 |
| Graph 1d |
Graph 1d: 1998 value (nominal terms) of €1,270 invested in 1978 |
This impressive performance of equities has not been confined to any particular market. Rather, similar results have been a feature of most developed countries, as highlighted in Graphs 1c and 1d.
Looking specifically at the Irish case, there has been a marked difference in the performance of each of the various asset classes in recent years. With interest rates falling steadily (Graph 2), leaving your money on deposit would have resulted in a significant opportunity cost relative to many investment alternatives.
| Graph 2 |
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Graph 2: Relative Performance of the ISEQ compared to the Irish 3 month interbank rate, from June 1993 to June 1999 |
Risks Attached to Equities
Equities risky over the short term...
In spite of their attractions, the element of risk attached to investing in equities should not be overlooked. Equities as an asset class do not follow a consistently upward trend and indeed can exhibit sharp volatility over short time horizons. For example, as Graph 3a illustrates, during 1987 the US market fell over 30% from its highest peak to its lowest level.
| Graph 3a |
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Graph 3a: Performance of DJIA over the period 1996-1997 |
...but not over the longer term
Nevertheless, even an investor who had invested at the top of the market (and thus felt the full impact of this downturn), by remaining fully invested would have recouped all losses within just 2 years, as Graph 3b show.
| Graph 3b |
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Graph 3b: Performance of DJIA over the period 1986-1987 |
Although the merits of investing in equities are clear, they should not be taken in isolation. Shares are not suitable for all investors; nor are all shares appropriate for every investor.
