A Warning on Stock Investment

We all rely heavily on the stock market with a significant chunk of our wealth reliant on it, particularly through our pension.

Pension Scheme Dangers

What typically happens is we go through our working lives making monthly contributions into our pension (defined contribution plan) in the crazy and naive hope that miraculously the market will keep on rising and we can enjoy annual average investment yields of 8 or 9%. Welcome to the real world everyone, in reality this doesn’t happen! What does happen is we have periods when markets will lose you money and long periods when you will make money. How these patterns are determined is whether you buy-in when the markets are under or over-valued.

Beware- Overvalued Stock Markets

At the moment, based on a number of indicators markets are most definately over-valued! So what does that mean for our annual average returns over the coming 10 or 20 years…well they are unlikely to be very good and will result in a disappointing retirement pot. This knowledge has come from a fascinating book I have just been reading called “Unexpected Returns” by Ed Easterling.

http://www.crestmontresearch.com/stock-matrix-options/

Please follow this link to an amazing chart which shows a matrix of annual stock market returns since 1900 over whatever holding period you choose. Please study the matrix, it reveals some fascinating insights. In particular, if you invest into overvalued markets (ie. when price to earnings ratios are above 20), it shows how long you will have to hold your stocks for before you will a achieve a decent positive return. For example, if you invested in the early 1930′s you would need to have held that investment for 20 years to see a positive average return, scary! We now appear to be in an environment when price to earning ratios are very high, it may well take at least ten years to enjoy a decent return.

Now, all of this is not to say that stock market investing is a bad idea, it is just important to buy-in when markets are undervalued, therefore giving yourself a high chance of achieving a decent return over a 10 or 20 year period. At the moment some European markets look cheap, especially Italy, Spain and Germany where worries about the Eurozone may have been over done. In fact, I was reading that at the moment these markets have not been this cheap compared to US equities since the 1970′s! Other markets worth investigating would be my old favourite Japan, but avoid the US!