Personal Finance: Fools go the distance

The 'Motley Fool' started in the US as an investment newsletter and has developed into a $10m internet and publishing business. The heart of its philosophy is that we can all learn to run our own finances - and get better returns than the experts. Those who follow its advice are Fools.

This week: the bible of the long-distance investor.

THE MOST thrilling read in Britain is not to be found in any bookshop. The Barclays Capital Equity-Gilt Study is not a snip at pounds 100 but the information it contains is priceless.

Published every year since 1956, this study looks at the returns of British shares against gilts and cash since 1918. Look at the graph, which shows the total return of shares on the London Stock Exchange between 1918 and 1997.

The Equity-Gilt Study tells us that shares have, on average, returned 12.2 per cent a year since 1919, and that is including the Great Crash of 1929. Gilts, which you will remember are government bonds, have returned 6.1 per cent a year over the same period, and cash in a deposit account just 5.4 per cent annually. From 1945 to 1994, property returned 8.5 per cent a year. At the same time, inflation has been 4.1 per cent on average from 1919-67 and 6.2 per cent from 1946-97. All roads lead back to compound interest. If we had had a solvent ancestor with sufficient foresight and compassion to invest for his grandchildren back in 1918, and he had decided to invest pounds 100 in the various options, how would he have fared? As you can see in the figures on the left, there is no competition. Misguided people say you should not put your money into shares. Long term, we have seen that isn't so. But what about the short term?

Taking all four-year periods since 1918 (1918-22 etc) equities (shares) have outperformed cash in 82 per cent of them. For gilts, the number is 84 per cent. For consecutive 10-year periods, the numbers rise to 97 per cent and 96 per cent.

Having said that, there's danger aplenty in the stock market if you are going to approach it in a reckless and impulsive manner. Look again at the stock market graph. There are groups of several years where it drops. Those who sell out during this time, losing large amounts and swearing off the market forever, in most cases deserve what they get. Anyone who invests in the market with an ultra-short time horizon - less than five years - is spinning a roulette wheel.

Can shares keep rising?

How far can shares go? Over the long term, the market reflects the growth of business. So, will business always grow? Could there ever be a prolonged period - as long as a human lifetime - in which business and thus the stock market fails to grow, or even shrinks?

Well, what sustains business? A large number of factors, primarily things like population growth, environmental conditions and government stability. Increasingly, advances in science and technology are also fuelling growth. Do you at present perceive conditions which would lead to stagnation or decline?

It is easy to create scenarios in which that would happen, but most of them involve events such as nuclear war or an asteroid impact. In each of these situations, the performance of your investment portfolio would be the least of your worries.

Our own best guess is that as long as civilisation is around, you will continue to see long-term growth in business and in the world's stock markets.

Next week: Be your own financial adviser.

Extracted from the 'Motley Fool Investment Guide' by David Berger with David and Tom Gardner, published by Boxtree at pounds 12.99. David Berger, David and Tom Gardner 1998. For a copy call 0181-324 5522.

Return on pounds 100 invested

Dec 1918 Dec 1997 Dec 1997

Real terms*

Cash pounds 100 pounds 6,521 pounds 324

Gilts pounds 100 pounds 10,652 pounds 528

Equities pounds 100 pounds 884,714 pounds 43,891

*Taking into account the effect of inflation. Source: Barclays Capital

other foolish investments

National Savings Certificates

You can put between pounds 100 and pounds 10,000 into NS Index-Linked Certificates. They are currently growing at the rate of inflation plus 2 per cent and are tax-free. They can be useful for any old Fool who needs a pot of medium- term cash. For details call 0645 645000. Alternatively, stop by the website at www.open.gov.uk/natsav.

Corporate bonds

If you buy shares in a company then you become a part owner. If one day the company goes bust then you as part owner will be one of the last people to see any money back. Everybody the company owes money to will be paid off first.

Being the owner of a corporate bond, on the other hand, puts you in a different relationship. What you have done is lend the company a sum of money. It agrees to pay you that money back at a specified date in the future, plus a yearly rate of interest, say 8 per cent. Bonds have different safety ratings but mostly they are pretty safe.

Nothing comes for free and you have to pay for this almost absolute assurance of safety with far lower long-term returns on bonds than on shares. That said, corporate bonds are another Foolish store for medium-term money.