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Stock markets are at all-time highs but taking advantage of two of investing’s principles can reduce your risks.
Earlier this week, the US stock market reached twice the level of its pandemic lows.1 After a sharp correction in March 2020, when the Covid-19 pandemic swept across the global economy, equities are now higher than ever and many investors are sitting on big profits.
So, what should investors do now? One financial advisor asked me last week if his investors should take their profits. My answer was no; trying to time the market is speculation. Far better to hold on and take advantage of two of investing’s safe bets.
The first is that over the long run equities are expected to outperform – do better than – cash or short-term bonds. The second is that diversifying – or spreading risk – reduces the danger that falls in equities will damage your investments.
Let’s start with the outperformance of equities. The term equity risk premium refers to the outperformance investors get for investing in the stock market over the risk-free rate –usually thought of as a three-month government bond’s returns.
As equities are higher risk than short-term bonds, they compensate investors for taking that extra risk with greater rewards. Certainly, over time that has proved true. For instance, the MSCI World Index has generated an annualised return for investors of 8.63% over the 33 years since it was started on 31 December, 19872 – far more than US 3-month Treasury bill, which is just above zero today but was over 5% at the beginning of the 30 years.3
This equity risk premium means that equities are likely to carry on outperforming cash and bonds, as long as you have the patience to remain invested for the longer term, riding out any temporary falls.
Performance of the VanEck Vectors Global Equal Weight UCITS ETF
Source: VanEck. Past performance is not a reliable indicator for future performance. Data for the period 14/04/2011 (launch of the ETF) until 03/08/2021. Returns are total returns, including reinvested dividends, assuming dividend taxes are reclaimed.
The way to minimise the danger of these falls is diversification, or spreading risk. The famous American Nobel Prize laureate, Harry Markowitz, is reputed to have said, “diversification is the only free lunch in investing4.” By this he meant that by spreading your risk around you limit the danger of falls in prices, and so improve your long-term returns. What’s more, this doesn’t cost you anything.
One way to do so today is by investing in ETFs with equal equity weightings rather than those based on normal market indexes that today leave you heavily invested in US big tech. More than 15% of the MSCI World Index, for instance, comprises US tech names like Apple, Microsoft and Amazon5. Yet an article in this week’s Financial Times highlights the dangers that US tech giants could fall. Since 1970, companies that finished a decade in the top 10 biggest globally by market capitalisation have had a less than one in five chance of finishing the next decade there, the article reported.6
At VanEck, we have several ETFs that are based on equal-weighted indices and reduce this risk. These include the VanEck Vectors European Equal Weight UCITS ETF and the VanEck Vectors Sustainable World Equal Weight UCITS ETF. Note that our VanEck European Equal Weight ETF is one of the best performers on a 5-year relative basis amongst comparable European equity ETFs7. The ETF has now nearly seven years of track record. It provides exposure to 100 stocks from developed European countries. Its total expense ratio is 0.2%.
But another way you can spread your risk is over time. By investing regularly – even when markets are falling – you reduce the danger of investing a large lump sum just ahead of the types of market falls that cannot be predicted.
As I reassured my financial advisor, a look back over the history of investing will show you that the equity risk premium and diversification are safe bets. Expect them to continue to deliver over time.
Footnotes and Disclosures
1US stocks double from March 2020 pandemic closing lows. Financial Times.
2Source: MSCI. Data as of 30/07/2021.
3Source: YCharts. Data as of 17/07/2021.
6How the US tech giants could fall. Financial Times.
7As follows from comparing ETFs in the category Europe Large-Cap Blend Equity at a European Morningstar website, such as Morningstar.co.uk.
VanEck Asset Management B.V., the management company of VanEck Vectors Sustainable World Equal Weight UCITS ETF, VanEck Vectors Global Equal Weight UCITS ETF and VanEck Vectors European Equal Weight UCITS ETF (the "ETFs"), sub-funds of VanEck Vectors ETFs N.V., is a UCITS management company incorporated under Dutch law and registered with the Dutch Authority for the Financial Markets (AFM). The ETFs are registered with the AFM and track an equity index. The value of the ETF’s assets may fluctuate heavily as a result of the investment strategy. If the underlying index falls in value, the ETF will also lose value.
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Performance quoted represents past performance. Current performance may be lower or higher than average annual returns shown. Discrete performance shows 12 month performance to the most recent Quarter end for each of the last 5yrs where available. E.g. '1st year' shows the most recent of these 12-month periods and '2nd year' shows the previous 12 month period and so on.
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