Mark Lister, 27 April 2017

New Zealand share investors have been spoilt in recent years, with share returns very strong and little in the way of major corrections to slow things down. This has fooled many into overestimating future expectations and underestimating how often things go down.

Looking at rolling 12-month returns for the local market, I had to go back almost eight years to find a negative number. That’s an impressive run. Investing conditions are usually tougher, returns more difficult to come by and ‘down years’ more frequent.

I went back further and looked at the last 50 years. Over this period, the annual return was negative 24 per cent of the time.

To put it another way, over the last 50 years you’d have experienced a negative year every 4.3 years. That sounds a bit scary, and is probably more frequent that many would have guessed.

However, many of those negative years were falls of just a few per cent, blips that would have gone unnoticed by many. Annual declines of ten per cent plus were much rarer, only coming every 7.8 years.

Falls are falls though, and that’s something people should expect when investing in higher risk assets like shares.

It’s not all bad news. In return for that volatility you get better long-term returns than you would elsewhere. NZ shares have delivered 9.7 per cent per annum since 1967, which is a little misleading because of exceptionally high inflation during the 1970s and 1980s.

Returns are influenced by inflation, so it’s better to think about these in ‘real’ terms, after inflation has been subtracted.

Inflation has averaged 6.0 per cent over the last 50 years, so shares have returned 3.7 per cent annually, in real terms. House prices aren’t far behind, with a 3.0 per cent real return over that same period.

I looked at the US market and got similar results. In the last 150 years, US shares averaged a negative year in every three. Like NZ, 10 per cent falls were much less common, every 5.8 years on average. Interestingly, the real return from US shares was 3.7 per cent, the same as ours.

So what does this all mean?  For a start, the last decade hasn’t been normal. Returns have been above average, and volatility very low.

If history is anything to go by, share investors should expect roughly every fourth year to be down. Most will be fairly small declines, so no need to panic, but if you’re not in it for the long-term or you can’t stomach the ups and downs, you’re in the wrong investment.

Over the longer-term, you can expect good returns from your share portfolio. However, ‘good’ doesn’t mean the 15 per cent average of the past five years, I’d call that ’exceptional’.

Shares will give you 3-4 per cent above the inflation rate, so if you think annual inflation will be 2-3 per cent over the next decade, assume your shares will do about 6-7 per cent, including cash dividends.

Anyone promising substantially more than that is either highly optimistic about economic growth, inflation and corporate profits, or is leading you up the garden path.

This article was published by The New Zealand Herald on 3 May 2017 under the title ‘Mark Lister: Don’t be fooled by sharemarket’s bull run’.