At Moneystepper, we generally advise that people place their long term investments into the stock market via low cost market tracking funds and ETFs in order to receive an average of 10% returns annually. But, is it dangerous to invest in the FTSE 100 right now?
This long term investing advice always comes with the disclaimer that investing in the stock market should only be done if you are investing for the long term (over 5 years, and preferably over 8 years) and that markets can go down as well as up.
It’s this last point that we are going to address in more detail today, by looking at the dangers of the current markets to determine is it dangerous to invest in the FTSE 100 (and other major indices) right now.
Before we do, I just want to summarize where that 10% return figure comes from as many people may have heard it (or similar figures) quoted, but not seen the backing support.
At Moneystepper, we use the figure based on the average return of major UK and US indices over the past 30-50 years.
- FTSE 100 at 6.1% per annum over 31 years plus dividends of around 3% per annum gives around 9%
- FTSE 250 at 8.3% per annum over 29 years plus dividends of just over 2% per annum gives around 10.5%
- Dow Jones Industrial Average at 9.3% per annum over 30 years plus dividends of just over 2% per annum gives around 11.5%
- S&P 500 at 7.6% per annum over 65 years plus dividends of just over 3% per annum gives around 11%
An average of all the above gives around 10% per annum average returns in the long term.
Is It Dangerous To Invest – Reason 1: The FTSE 100 Has Never Gone For More Than 6 Calendar Years Without A Fall Of Over 5.5%
Whist the average annual increase is around 10%, the short-term performance is usually much more volatile. For instance, in the FTSE 100, 2008 brought a 29.5% fall, 2002 saw a 30.1% fall and 1994 a 10.1% decrease.
In fact, the FTSE has historically never had a 6 year run without a fall of over 5.5%.
However, since the 2008 tumble, the FTSE 100 has returned:
- 2009: 35.5%
- 2010: 9.5%
- 2011: -5.2%
- 2012: 6.9%
- 2013: 7.5%
- 2014: -3.0%
So, people are concerned that it is currently dangerous to invest in the markets because we are due a large fall based on historical cycles.
Is It Dangerous To Invest – Counter Argument 1
Whilst it may be true that we usually have a fall every 5-6 years, the numbers above actually may tell us a different story.
Remember that the FTSE 100 increases historically by an average of just over 6% a year excluding dividends.
The average return over the past 5 years from the FTSE 100 is only at 3.1% per annum. This negates the need somewhat for the market correction.
Looking at the historical “corrections”, each had a period of significantly higher than average performance in the preceding 5 years:
|Year||Fall||Preceding 5 years|
Is It Dangerous To Invest – Reason 2: The FTSE 100 Is At All-time Highs
At the close of play on Friday 20th March 2015, the FTSE 100 closed at 7,022.51, which is an all-time high value.
People generally think that it is dangerous to invest in the markets when they are at an all-time high because they must be overvalued and therefore due a tumble.
Is It Dangerous To Invest – Counter Argument 2
I’m not going to spend too long addressing this point, but will refer you to the following two articles which address why timing the market is not a good idea based on price, and that the market actually is a long way behind all-time highs when inflation is taken into account.
Is It Dangerous To Invest – Reason 3: Dangerous Debt Levels
This may be the most concerning reason why it may be a dangerous time to invest in the markets.
The 2007-8 financial crisis was largely blamed on the unmanageable levels of debt in the finance sector which led to the downfall of Lehman Brothers and the fall of many other UK, European and US banks.
But what were these debt levels and how have they changed since the 2007-8 financial crisis?
Let’s start with the US Debt. In 2007, total US debt peaked at 337% of GDP. This can be very basically thought of a person having 3.37 times their salary in debt.
This was considered to be a significant factor in the last crash and a market wide review of capital requirements.
At the end of 2014, total US debt is now…332% of GDP.
All that has really happened in the 7 years is that the debt has moved from the private sector to the public sector as government debt in the US increased in the period from 64% of GDP in 2007 to 102% in 2014.
Is the situation any different in the UK? Nope, in fact it may be worse. UK Debt (including financial sector) was 400% of GDP in 2007 and was pushing 500% at the end of 2014, with public debt surging from 43% to 91% of GDP over the same period.
But, why is this dangerous for markets?
A comparison to Japan’s journey over the past 20 years tells us why.
Between 1992 and 1997, Japan’s public debt increased in a similar range (from 65% in 1992 to 100% in 1997). Since then, this has only increased, reaching 175% in 2007 and 225% in 2014.
What has happened since the rise of public debt between 1992 and 1997 in Japan? Simply, they’ve suffered 15 years of deflation and a stock market that has gone from about 22500 to 18603 as I write this article. Over the course of 15 years (long term) the market has fallen by 17%.
Just for comparison, over the same period, the FTSE 100 was up around 100%.
And what is happening at the moment in the UK and Europe: there is a serious risk of deflation. Markets beware…
Is It Dangerous To Invest – Reason 3: Counter Argument
The argument against this is three fold:
- The current situation in the US and UK is vastly different to Japan’s plight in many other areas and hence a direct comparison is not fair.
- Government Debt of 100% of GDP may not be all that high. Think about if you had a mortgage on your house equal to your annual salary. That wouldn’t be considered too high, would it?
- The latest budget suggests that this debt is now due to significantly fall.
Is It Dangerous To Invest In The FTSE 100 Right Now? – Conclusion
There are arguments to be made that it is currently a dangerous time to invest in the markets. However, these arguments always exist and is exactly the reason why people should only invest in the markets in the long-term (more than 5-8 years) and why dollar cost averaging (not putting all your money into the markets at once) is considered a sensible approach.