To win the equity game we need to be optimistic Triumph like an Optimist

Healthy scepticism might be a virtue, but an overly pessimistic outlook makes it hard to take advantage of equities' long run outperformance

 Triumph like an Optimist

 

Equities outperform in the long term. That is an empirical fact. There are plenty of ways to play around with the data, like choosing convenient measuring periods and being selective with samples; but over very long periods it’s unarguable that equities provide superior returns to other mainstream asset classes. Over the last century their real return was something in the order of 5 to 6 per cent per annum in real terms.

Triumph of the optimists

In their major study of twentieth century global investment returns, academics Dimson, Marsh and Staunton appropriately titled their book which analysed these pro-equity findings, ‘Triumph of the Optimists’. Which is a very nice description of the outcome.

To be a successful equity investor I firmly believe we have to be fundamentally optimistic. Not in a Panglossian ‘all is for the best in the best of all possible worlds’ type of naive optimism. But rather it helps to approach an investment with a mindset which looks at what might go right.

Of course it’s important to be sceptical and not lose sight of the risks to that upside case: that’s a key element of being a good investor. However if our primary focus is on how we might lose money, due to our adopting a pessimistic approach, then we are likely to turn down too many great opportunities to make much of a success of equity investment.  

Media bias

My thoughts about optimism are long-held and I’ve often been frustrated by what I’ve perceived over the years as an institutional bias in the media against equities and especially equity bull markets. It’s almost as if journalists relish bear markets and feel it’s far too easy for investors when stocks rise. Just think of the number of times we have read about the ‘overvalued US stock market’ over the last three or four years while it has gone on to make new high after new high!

Well it turns out that financial journalists really are consistently biased in favour of negativity. At least they are according to a study cited in an interesting article by John Authers in the FT recently.  

Mr Authers admits to this trait himself and suggests that his negativity might be down to the profession’s requirement to be sceptical and always questioning. Protecting readers from making losses is also seen as more important than helping them make money. It’s certainly the case that people feel more pain from a loss than the pleasure they take from making a similar-sized profit. So maybe journalists are right to see the glass as half empty. Being cynical, it’s also possible that bad news sells more papers than good news!

Weighing risk

Maybe pessimism is why journalists write about investment rather than practise it. The simple fact is that equity investment involves losing money from time to time. This is something we investors just have to deal with, rather than be protected from by well-meaning journalists. If we weigh risks correctly and take a genuinely long-term view of our portfolios, then our losses will always be overwhelmed by our gains. Even when those temporary losses are substantial, which they might well have been in 2001-2 or 2008.

So if you’re permanently cautious and have no stomach for risk-taking, then maybe equity investment simply isn’t for you – take up journalism or the bond market instead!

 

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