Equities are the ultimate long game

When the US business school NYU Stern looked at the performance of equities from 1928 to 2023, it calculated that $100 invested in the S&P 500 during that time would have grown to $787,018 by 2023 with dividends reinvested.

These kinds of gains are the pay-off for equities’ volatility, and the trajectory over those 95 years was far from steady: the S&P 500 plunged by over a third on three occasions along with many smaller falls.

Bonds are a different story. During that time frame, the worst declines for US investment grade corporate bonds rated BBB were just over 15 per cent, and this only happened twice. But in contrast to equities, these bonds turned $100 into just $49,525.21.

Investors are fearful

These figures are hardly a secret to investors, and other studies have drawn similar conclusions. Nonetheless, Capital Group commissioned FT Longitude to survey 450 high net worth investors across 10 countries in Europe, Asia and the US. It found that 59 per cent of investors have cash holdings of 10–20 per cent; 11 per cent have cash holdings of 21–30 per cent. Many experts believe it should be under 10%. The stock market’s volatility has clearly shaken some investors: over 10 years, 72 per cent see shares as risky, compared with 39 per cent who view holding cash this long as risky. 

Yet holding cash over a 10-year period is typically a wealth trap when compared with holding equities. “The US economy has grown in 85 per cent of all months since the end of WWII,” says Kristen Bitterly, head of investment solutions at Citi Global Wealth. “And US equity returns have been positive in 78 per cent of all years over the same period.”

Investors, however, see plenty ahead to fret about. Almost half of the world’s population is voting in elections this year, for instance, and political uncertainty can cause market volatility. Then there are global geopolitical frictions such as the Israel-Hamas conflict and the war in Ukraine.

The wall of worry versus inflation erosion

Historically, stock markets climb a ‘wall of worry’. The S&P 500’s meteoric rise happened despite a Great Depression, two world wars, financial crises, political strife, inflation and a pandemic. “Between wars and crises, there's always a reason not to invest,” says Grace Peters, global head of investment strategy at JPMorgan Private Bank. “And yet markets go up as long as the economic growth outlook looks reasonable.”

Another reason why many investors are sticking to cash is interest rates, which are at their highest in more than 15 years. But the danger for these investors is that cash is prone to inflation erosion. “Cash has tended to deliver much lower long-term returns than equities, bonds and alternatives,” says Mark Haefele, chief investment officer at UBS. “And going forward we expect lower returns from cash relative to those assets.”

Time in the market beats timing the market

Investors may also be trying to time their purchases. But this also risks damaging their wealth. “The problem with trying to time the market is that you risk selling low and buying high,” says Winnie Kwan, equity portfolio manager at Capital Group. She explains that almost no one noticed one of the greatest equity bull markets of all time when it started on 6 March 2009. She adds that the market fell to a low on 23 March 2020 during the Covid pandemic that went unnoticed by most until the market had rallied significantly.

For cash-laden investors, the past 12 months have been expensive in terms of missed opportunities. In the year to 15 March 2024, the S&P 500 returned just over 30 per cent, compared with 5 per cent from cash in US dollars.

Research by Bank of America using data between 1930 and 2020 has found that if an investor missed the S&P 500′s 10 best days each decade, their total return would have been 28 per cent. If they had stayed invested during the market’s ups and downs, however, their total return would have been 17,715 per cent.

Despite the S&P 500’s recent rise, many analysts believe there is more growth to come over the next three years. One way for cautious investors to balance equities’ volatility is to spread out their purchases over 12 to 18 months so that if markets fall, they can buy shares more cheaply.

Are equities right for everyone?

For younger people who are looking to build wealth, it makes sense to be heavily weighted towards equities. For those who are approaching retirement, wealth preservation is more important, so placing more emphasis on bonds and less on equities is prudent. And, over the long term that is still likely to be better than being heavily invested in cash.

“We do expect rate cuts, which tend to benefit returns on bonds and equities and hurts returns on cash. And we typically see those returns begin to happen before the first interest rate cuts. You need to be in the market and you are better to be in it before the cuts begin,” says Willem Sels, global chief investment officer, HSBC Global Private Banking and Wealth.

Investors who can tolerate the high volatility of equities are rewarded with better prospects for wealth creation over the long-term.