Stock

One of the disappointing things about, mainly, the stock market is that private investors are truly terrible at deriving benefits.  Not so the residential property market.  When it comes to their own homes, people tend not to sell when the market drops; partly because they need a roof over their heads, partly because property is illiquid and most difficult to sell just when you need to do so most quickly, but mainly because homeowners do not want to realise any apparent loss on their home.

The good news for homeowners has been that they spend their 100% of the time invested in the market and, even though they experience slumps in value from time to time, they are always ideally placed to benefit from any upturn.  If you expect the trend to be upwards over the long term, this is a rational way to behave, even if the reasoning is less than analytical.

If we contrast this behaviour with that of the same people in the stock market, it tells a very different story.  Investors seem to head for the market at outset with no particular plan in mind and no thought to timescales or their own expectations.  Perhaps, they have responded to lurid headlines of fantastic returns being made somewhere and worry about missing out.  This may be why so much retail money floods into the fashionable sectors and funds.

If the market drops in value, these same investors sell quickly and move into, for example, cash, worried that losses would become even greater.  Worse still, many simply look at the best performing fund over the last three years, say, and decide to pile into that.

This is why the latest research from Lipper Feri is so depressingly familiar.  Outflows from some very sensible sectors are huge and funds like the Merrill Lynch Blackrock Gold & General Fund have benefited enormously, in its case to the tune of more than £300m.  Now, I am not suggesting that this is the bottom of the market, nor am I saying the Gold & General Fund, which has ridden the good news in commodities, is the wrong place to put money.  All I say is that it is pretty depressing to see all these investors chasing their tails, most simply guaranteeing that they will lose money.

Far better, surely, to have some sort of plan at outset and to use knowledge of the past to manage expectations of the future.  As people have discovered in property, buying into the market and sitting tight forever is not a bad strategy. 

For those looking for indications of a forthcoming boom in share values, yesterday’s FT held out some hope.  It reported on research published by the Washington Service who track legitimate insider share trades for 1,900 New York listed companies showing that senior executives and directors bought significantly more shares than they sold. 

According to the FT, the last time company insiders made net share purchases was January 1995 and the S&P 500 grew by 34.1% in that year.  Of course, this is a sample of one so it pays to be cautious but many investors will be hoping for a repeat this year.  That said, the FTSE responded by falling more than 160 points.

Is the stock market, as a whole, an inherently riskier place to invest money than the residential property market?  Now, I am not for one second suggesting that either is an appropriate place to put your money, although one or both may be, I am just opening up the discussion.  I am also considering the property market in investment terms rather than housing terms, no share portfolio will keep you dry through the winter or give you somewhere to show off your latest plasma TV.  These thoughts are probably, therefore most applicable to excess property investment, by which I mean a second property, a buy-to-let property or a house larger than your requirements, which you hope to sell to fund your retirement.

Firstly, what do we mean by risk?  It is, I suggest, unlikely that the stock market or the property market will drop in value to zero.  It is, of course, possible to make a bad choice of investment.  Some companies will go bust and some properties may become worthless, perhaps because of flooding or encroachment by the sea.  Now, you would be daft to buy a property without insuring it against these risks but most people will buy a share in a company without any corresponding insurance against loss (i may cover how another time).  This, then, starts to colour our view of the relative merits of the investments; we take more risk with our stocks, for some reason, than we do with our real estate.

The world of professional investors usually expresses risk in terms of the volatility of returns.  An investment which can deliver high returns with periodic big drops in values is considered to be riskier than an investment which is more steady in its delivery, even if they end up at the same spot.

So, how does volatility compare?  My main concern here is one of information delivery.  If you valued your share portfolio every year, it may not look particularly volatile and, indeed, in most years it would have gone up in value, probably even in 1987.  This is where the stock portfolio is at something of a disadvantage when compared against property.  You see, property is not valued by anyone, let alone the market (as distinctly opposed to an estate agent or even a surveyor) in anything like real time.  Depending on how often we move, a property may only be market valued, i.e. bought, once every seven years.  We may read in the press about the general sentiment but no one is able to rub our noses in its value in real time, minute by minute.  If you own a stock portfolio, you can watch it go up and down every minute of the working day, responding instantaneously to investor sentiment, and it can be frightening for some.

Also, I have referred to a stock portfolio as opposed to one stock, mostly, as it would not be rational to hold only a couple of different shares.  Diversification is easy with shares, not so with property as it is expensive and slow to sell, amongst other things.  

What of the returns?  Well, ignoring income form dividends or rent, which I gauge to be similar after costs, I think property and equities have probably delivered similar capital growth.  If you take into account transaction costs and the difficulties of diversifying across a number of properties, it may well be that a property portfolio has lost ground to a share portfolio.  What, though, will the next twenty bring?

Why does the Stock Market (and other markets, for that matter) move, sometimes by quite a bit, from one day to the next?  Can it really be that the long term outlook for companies differs significantly between Monday and Tuesday?  To put these movements into context, they are normally not that great; a change in value of 1% is headline stuff as in 'Billions Wiped of UK Stock'.  Hardly confidence building stuff for private investors.

In many ways, investors are much like flocking birds.  If you observe a flock of birds in the evening before roosting, whilst they all move as one, there actual direction seems completely random.  These birds are programmed to follow each other, if one changes direction, the one next to it follows closely and they all change direction.  In nature, this behaviour serves a purpose, these animals stick together for safety and social reasons and it is safer for a bird to follow its neighbour than not, it may have spotted a predator.

Like the flock of birds, the market has no leader showing the way and it seems to move in an entirely random way.  Albeit, we expect a long term upward trend.  The financial press puts a great deal of effort into explaining these market movements afetr the fact but, in truth, investors are just flocking most of the time.  There will, of course, be the odd, random event which greatly changes the long term outlook but, for long term investors, even these should not be seen out of context.