Most things that are traded on markets vary in price every day. So why do variations in share prices worry us so much?
It’s true that since last autumn, we have seen a lot of volatility in share prices. Between 2003 and 2006 there were few days in which the FTSE 100 Index varied by more than 1%. Since last October, there have been over a dozen, and we’ve also had several days of 3% variation both here and on Wall Street.
The media response to this is predictable if stupid. It is ‘BILLIONS WIPED OFF SHARE PRICES’ when the market falls 2% and complete silence the next day when it rises by 2%. Have you ever seen the headline: ‘BILLIONS ADDED TO SHARE PRICES’? No, and you never will.
We all know that it’s bad news that sells newspapers, so we ought to mentally correct our perceptions for this bias, but in fact we don’t discount the bias as much as we should. So most people probably believe the stock market is in terrible shape, whereas in fact the Footsie is down 15% from the high of 6,600 it reached in 2007 after three years of steady gains
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Better value today
But you can’t just look at prices. Since 2003 company profits have soared. That means UK shares are now better value - you buy more dividends and earnings with each share - than they were in 2003. So for long-term savers and investors, shares remain a good home for your money. The fact that very few people are prepared to say that in print is exactly what you should expect when irrational fear is dominating the market.
We know why the market is down. Not because economies are slumping, sales are falling and profits are collapsing. None of this is happening. It’s just that the banks are in trouble. In fact it’s the big falls in bank and other financial shares that account for a lot of the fall in the market index.
True, if banking troubles aren’t checked, they can create economic havoc. But on the evidence to date, the US Federal Reserve is doing what’s necessary to tidy up the sub-prime mess. It may take a few more months before everyone is convinced that the worst is over.
But you have to be very pessimistic to believe we are on the verge of a great slump. Only complete idiots could be in charge of an economic system that allowed the ill effects of excessive lending to a few million Americans to destroy the world economy.
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The right time to buy
Gloomy headlines are one of the best buying signals. This is all about psychology – as I’ve already said, the reality for most businesses is pretty good. ‘The market’ – which means investors- has talked itself into a state of funk, in which people really believe the collapse of the financial system is a possibility.
At some point, probably quite soon, people will realize this is nonsense, and will quickly forget the doomy gloomy things they believed just a few weeks before. And when the mood shifts from ‘glass half empty’ to ‘glass half full’, you can expect substantial gains in share prices.
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TER: Total Expense Ratio. * Including reinvested net income. Data to 1/4/08. Source: Financial Express.
Keep it simple
If you want to keep it simple, use an index-tracking fund for your investments and lump sum savings. The index tracker fund is one of a handful of ‘buy-and-forget’ investments. Because it holds shares in the same proportions as the index, you effectively get a stake in about 700 UK companies. Moreover that stake is managed, since every three months the index is revised and some companies drop out while others are included.
With an index tracker, most of your money is invested in the shares of the biggest companies such as BP, HSBC, GlaxoSmithKline, Tesco and so forth. The managers simply buy the shares for the fund in the same proportion as they occur in the index.
This ‘passive’ style of managing investments has been shown by the academics to be more successful than the vast majority of actively managed funds over the long term (periods of over 10 years).
Our selected index tracker funds are those with low costs. Many index trackers charge 1% a year- big names include Virgin, Legal & General and HSBC, and some also levy an initial charge when you buy. Our selected funds do exactly the same job but make no initial charge and their annual costs are half as much or less. The absolute best value is Fidelity Moneybuilder UK index, whose total expense ratio (the total of all annual management costs and charges) is just under 0.3%. You can buy this fund on the FundsNetwork supermarket directly in your own name or in an ISA, and for lump sums or regular savings.
Important risk warning - please read
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance. If you are in any doubt as to the suitability of an investment, you should seek independent financial advice.
