One-year wonder not so wonderful
The figures seem to argue against all the conventional wisdom on investing in shares or share funds.
If you invest in New Zealand shares for just one year, you have a 30 per cent chance of getting a handsome return of more than 20 per cent. But if you invest for three years, the chance of getting such a high annual return falls to 11 per cent. Over five years, it’s a mere 2 per cent, and at ten years, it’s practically zero.
Might as well go with just a one-year investment then, right? Wrong.
The trouble with a single-year share investment is that there is also a 30 per cent chance that you will lose money. Over three years, that drops to 16 per cent, at five years it is 8 per cent and at ten years — as above — it’s close to zero.
With a short-term investment, then, you’re much more likely to do either extremely well or extremely badly. That’s not a gamble most people want to take.
Over longer periods, though, particularly good years and bad years cancel one another out and leave you with a healthy average return, above what you would make in the bank.
Let’s look at that more closely, assuming a bank deposit return of 5.25 per cent. If you invest in New Zealand shares, how likely are you to make an average annual return above that bank rate?
Over one year, there’s a 60 per cent chance you’ll do better in shares. But that means a 40 per cent chance you won’t. That’s not great — and it fuels our argument against investing for just one year.
Extend the period to just three years, though, and you have a 69 per cent chance that you’ll do better than in the bank. And at five years, it’s a 77 per cent chance — more than three quarters of the time.
Hang in there for ten years, and you have a 94 per cent chance of outdoing your conservative neighbour who is sitting in term deposits. And at 20 years, it’s almost a dead certainty.
The message is pretty clear: Shares are a good investment. But everyone except gamblers should invest for the long haul.
These numbers are based on what’s happened over the last three economic cycles, about 20 years.
The data for world shares are similar, although there are some interesting subtle differences.
If you invest in world shares, you’re slightly less likely to either lose money or to make more than 20 per cent a year, over all periods, than in New Zealand shares.
This is probably because your investment would be spread over many different industries and markets. Greater diversification reduces volatility. When one market is down, another is up.
Looking at the chances of your world share investment making more than in a bank, they are a smidgeon higher, over all periods, than in New Zealand shares. The chances range from 61 per cent over a single year to 95 per cent over ten years.
World shares seem to have the edge over local ones, but only just.
CHRISTMAS SHOPPING
On an entirely different note, please watch your credit card spending this Christmas.
A recent report said New Zealanders spent an unusually high amount on credit cards during overseas travel this past winter.
If you haven’t paid off your winter holiday yet, it would be a big mistake to add Christmas spending to it.
Credit card interest is horribly high. People who regularly run up long-term credit card bills will retire considerably poorer.
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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.