In a recent article published in Alan Kohler's Eureka Report, financial education consultant Scott Francis reconsiders the debate about whether to invest in shares or cash. He takes us through two pieces of analysis which shows the premium from investing in shares over the long term.
The key points:A review of Australian stockmarket returns between 1958 and 2005, (see A Re-Examination of the Historical Equity Risk Premium in Australia) by academics Tim Brailsford, John Handley and Kirshnan Maheswaran, found that the market returned a 6.8% premium, even though the period included:
The actual return from investing in shares over this period was 14.5% a year. The authors reviewed data going back to 1883 but, to get the fairest possible result, 1958 was used as a starting point because the authors considered it the start of the period of reliable data in the Australian environment. (For the period 1883 to 2005, they found the average return from shares was 11.8% a year, with an equity risk premium of 6.6%.)Separately, researchers working for the leading brokerage Credit Suisse discovered a number of key factors:
- A number of recessions.
- The recession of the early 1970s.
- The 1987 stockmarket crash.
- The Asian economic crisis.
The other aspect addressed by Scott is the power of franked dividends. In Australia, the Credit Suisse study found that dividends in Australia between 1900 and 2008 have grown at the rate of 5.6% a year, higher that the rate of inflation over the period of 4.5% a year.
- Over the long run (1900 to end 2008) shares have provided an investment return (combined result from all global stockmarkets) of 4.2% a year higher than investing in cash.
- They argue that going forward they expect the return from shares to be about 3.5% a year higher than the returns from cash investments.
- In Australia, the return has been 6.5% a year greater for investing in shares rather than cash over the same period (1900 to end 2008).
- Their analysis confirms that higher returns have been achieved from investing in value and small company shares.
- They emphasise that shares are a volatile asset class, although they don't provide as much effort into trying to quantify this volatility.
- They studied the performance from shares after really good and really bad years. There did not seem to be any extra return following really good or really bad years.
- Dividends (the income from investing in shares) in Australia between 1900 and end 2008 has grown at the rate of 5.6% a year, higher that the rate of inflation over the period of 4.5% a year.
To take a look at the full article please click on the following link - Shares or cash? Look to the long term