Investors

Investors: Six reasons for optimism in 2012 
By Nick Louth

Being miserable about money seems compulsory as we enter 2012, and the newspaper headlines confirm it. No-one could blame us if we  just pulled the covers over our heads and waited for 2013.

Investing though is about running against crowds, seeing opportunities where others see only problems. That brings us to our first of six reasons to be cheerful this year.

Low expectations equal bargains

Most of the worst economic scenarios – bar the complete break-up of the euro – already seem to be accepted as fact, and are baked into share prices. Not all shares are cheap, but some are very cheap indeed. The global economy really won’t have to do very well at all to do better than those expectations, and that is where any gains will come from.

It is so much better to invest when everyone is gloomy, because their misery depresses prices and gives you bargains. Warren Buffett, probably the most successful investor in history, put his lifelong contrarianism pithily:

"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well."

Reinvesting dividends give secret gains

So much of what we think about investment is coloured by the past, and the colour is distinctly grey. The so-called lost decade of  share market investing, from 2001 to 2011 shows that FTSE 100 prices are pretty much back where they were ten years ago.

But if you look at the total return stats, you notice something different. Those investors who held the senior UK index and put back their dividends would have enjoyed a return of almost 4% a year, 48% by the end of the period.

Now that may not seem enthralling, but for the worst ten year period in a lifetime – since the 1930s in fact – it really isn’t bad. A return of 4% a year beats average inflation over that period. That tells you more about the power of compounding small amounts of income than it does about the state of investing in general. It is also a warning to steer clear of stocks that pay no dividend!

There is a better choice of income now

Given that income is key to long-term returns, the better an income you get, the better you returns will be. A good income is a high, growing and sustainable payout. Not just the highest, the last two parts of that sentence are very important too.

It is no good getting a high raw indicated yield of 15% from a company which is expected to cut or drop its payout. Far better to go for a less headline grabbing payout, which has been modestly but consistently increased over many years. Checking that available earnings cover the payout at least 1.5 times is a good safety belt. 

That is the secret behind the success of Neil Woodford’s Invesco Perpetual, which has thrashed the indices over many years by consistently investing in drug and tobacco stocks, which have had exactly these high, safe and rising incomes. 

Investing costs are falling

Cutting the overheads of investing is no-brainer. Management fees are wasted cash unless they produce gains that you could not replicate yourself. Don’t pay a manager 1.5% a year to hold Vodafone or GlaxoSmithKline for you, which you can hold directly, easily and cheaply. 

By all means, if you want to hold obscure Malaysian drug firms, or Bahraini government debt, do use a fund. But again, don’t spend more than you need to. Most investing positions can be cheaply held through trackers or exchanged traded funds – and there are more of them all the time.

Remember that even low fees sap your long term performance. 1% a year over 20 years will soak up a fifth of all the money you invest.

2012 is a good time to spring clean your portfolio 

Every portfolio gets stuffed with yesterday’s good ideas gone bad. It is essential to clean out those failed story stocks, the over-hyped and underperformed and reallocate capital profitably before any more is lost.

Failure to deal briskly with losing stocks is the biggest single cause of poor investment performance. The good news is that it is never too late to change, and there is no better time to do it than in a new investment year.

Don’t forget gilts

If you lived in Italy or Greece, the bond element of your portfolio would probably be in tatters. Here in the UK, gilts have crowned a glorious decade with an 81% total return. It’s something to feel grateful for.

In an exact mirror image of equities, most of these returns have come from price gains, a process that cannot continue indefinitely – though one which can certainly continue while we have ½% official interest rates.  

Investors can no long rely on gilts for income – right now it’s like tearing up tenners and letting them flutter into the wind. And the only way that gilts can produce a decent income is after a prolonged fall in prices that no investor really wants to experience.

So when the economy does perk up, which may not be until 2013, rates will edge up, shares will climb and gilts will sag. That’s the allocation switch that all investors need to look out for. With the US economy already trending up, that may well arrive on this side of the Atlantic towards the end of this year.

Be ready for it.

If you need help to be ready for it, let me review your portfolio. The aim is to add two points of performance at least through identifying and eliminating losing behaviour and beefing up what you’re already doing well at.
Click here to learn more.

Get a signed copy of Nick Louth’s gripping thriller ‘Bite’

http://www.ludensianbooks.com/bite/bite.htm

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