Cushioning uncertainty

Not too long ago, Europe appeared to offer investment sanctuary, apparently immune from the burgeoning economic crisis, yet the euorzone remains under enormous pressure.

To date, the Greek and Irish governments have each paid the price of sanctioning what could be generously called ‘lax’ lending policies which, frankly, wouldn’t be allowed if you were playing a game of Monopoly with your ten-year-old daughter.

The prospect of Ireland paying back all of its €85bn bail-out cash to creditors within the next six years, as is ambitiously planned, is rated by some economists as wildly optimistic.

Spain is another nation that has been subject to detailed scrutiny by investors over the past few months.

Prime minister Jose Luis Rodriguez Zapatero declared the country could ‘accelerate’ its austerity plans if necessary and has said there is “absolutely” no need for Spain to seek bail-out finance of any description.

But late in 2010, Barclays Capital estimated the Spanish Government needed to raise up to €73bn by the spring in order to finance its debt.

Recent events inside the eurozone have been enough to turn investors’ hair grey, but uncertainty is an economic and political constant, which means investors must deal with it.

However, today’s investment outlook is mixed with unprecedented levels of volatility, another of the investor’s deadliest enemies.

Little wonder there has been such a sustained stampede for gold, a traditional safe haven, although while the yellow metal’s price appears directly correlated to political and economic uncertainty — the more there is, the faster its value rises — gold’s principle drawback is that it returns no yield to buyers.

While many investors have no immediate requirement to draw income from their investments, another factor which has boosted demand for gold, this is not to say that income-producing investments are unimportant.

Far from it. The Barclays Equity Gilt Study, which collates investment returns going back to 1899, shows that over the intervening 110 years, equities have returned five per cent a year, compared with 1.2 per cent for gilts and one per cent for cash.

Most people invest for considerably shorter periods than a century, but the inevitable conclusion to be drawn from Barclays’ data is that the longer you hold equities, in particular the income-producing variety, the greater the potential for return.

This is also true in relative terms when equities are compared to other asset classes.

For instance, since 1899, shares have outperformed cash over two-year periods on 72 of the 109 occasions analysed. Over 10 year periods, they have outperformed on 92 of the 101 decade-long periods examined.

The most obvious inference to be drawn is that nothing reduces equity risk more than time itself. And so, in volatile, uncertain times, it follows that investors should aim to structure their finances in a way that buys them time by considering long-term, income-producing investments.

Indeed, the underlying value of dividend reinvestment is perhaps the most compelling feature of adapting a ‘buy-and-hold’ strategy.

As Barclays’ Equity Gilt Study reveals, had you bought £100 of shares in 1945, their value today would be £241. By reinvesting the regular dividends paid by companies each year, the figure rises to an incredible £4,011 and serves to illustrate the miracle of compound interest.

The great economist John Maynard Keynes famously declared: “In the long-term, we’re all dead.”

But for investors planning to hang around for a few years yet, it would appear the most important element of their total return is the reinvestment of dividends.

Granted, we can all get lucky with a sudden spurt in capital values — be it of equities or property, but over the long-term, the regular compounding of dividends or rental income can, as the figures above show, make an enormous difference and cushion the impact of economic uncertainty.