Some of my friends – like me – invest in the stock market. But many more of them don’t.
And why don’t those people invest in the stock market? When I ask them, it isn’t always clear. There’s always vague talk of risk, complexity, the perceived difficulties of doing it, and the fear of venturing away from the comfortable embrace of banks and building societies.
Even though that comfortable embrace is these days paying quite derisory rates of interest – often below the rate of inflation, and certainly a far cry from the rates on offer during the heady days of a decade or so ago.
Put another way, that comfortable embrace is actually eroding your savings, not enhancing them: every year, the purchasing power of your capital will shrink.
That’s certainly not my idea of wealth accumulation.
Different strokes
That said, investing in the stock market is very different from popping into the bank or building society to deposit the odd few quid.
There’s no denying that, and I’d be foolish to try.
Generally, for instance, you won’t be interacting with an organisation that has a high street presence at all – or at least, not if you want to avoid paying hefty commission fees. Instead, your relationship is with an online brokerage, with which you interact through your computer.
And while it is indeed possible to make stock market investments in quite a small way, as with your local bank or building society – you can invest in an index tracker for as little as £25 or so each month, for instance – investing such small sums isn’t going to be life-changing.
The stock market isn’t a savings account, either. You wouldn’t use it to save for a holiday: the buying and selling costs just wouldn’t make it worthwhile. Being sensible, the stock market is best viewed as a medium to long-term investment, over a period of several years.
So why would you invest in the stock market?
Long-term growth record
The first reason, I think, is the stock market’s historic outperformance of other investment vehicles.
According to the prestigious annual Barclays Equity-Gilt Study, for instance, over the past 50 years the stock market has yielded an after-inflation total return – capital growth plus dividends – of 5.6% per year, comfortably beating the 2.9% available from investing in gilts, and the 1.4% from cash.
Granted, the financial turbulence of the last decade and a half has taken the shine off that record a little. But over the long term, the stock market has been shown to deliver a comfortable inflation-beating return.
Individual outperformance
And that’s the stock market as a whole. Individual shares within the market have the potential to do many, many times better than that. Particularly if you patiently wait, and buy in at attractive prices.
As I’ve written before, a collection of beaten-down shares that I bought in the first few weeks of 2016 had recorded an average gain of 88% by the close of the year.
Nor are we talking minnows that no one has ever heard of. Oil and gas giant Royal Dutch Shell, for instance, and mining behemoth BHP Billiton, are very significant enterprises.
Granted – again as I’ve written before – to achieve this sort of performance you need to take the long view, avoid being panicked by bad news, and ignore short-term noise.
Buying an ownership stake
And finally, as a shareholder, you are very different from someone putting their savings in the bank or building society.
A bank or building society ‘investor’ isn’t an investor, but a depositor, depositing their savings for the bank of building society to in turn lend out to its borrowers.
On the other hand, you – as a shareholder – are an investor. You literally own a piece of the relevant business, taking a cut of its profits, in the form of dividends, and sharing in its fortunes, good and bad.
And this ownership dimension, when you think about it, is from where that long-term outperformance stems.
Buy a bond or gilt, and you’re lending money – money that is repaid when the term matures. Deposit money with a bank or building society, and your money is repaid when you withdraw it.
Buy a share, and you’re buying a stake in a business. And holding that stake, until you sell it.
Risk vs. return
For me – and many others – these are compelling arguments. I accept that they don’t float everyone’s boat, and that some are put off by the higher level of risk that share ownership entails.
But with interest rates remaining at exceptionally low levels, I know that it’s a risk that I’m happy to take.