Compelling reasons not to abandon the share market

With sellers far outweighing buyers in what has become a 'bear market' – which technically means a downturn of 20% or more – you have every right to question whether you should not only refrain from buying more shares, but abandon the share market completely and put all your money in safe havens like cash.

For those of you who like statistics, the S&P ASX200 index was on 12 February down exactly 20% since March 2015.

While DIY investors who buy shares directly are more prone to panic, those with shares in Super are left by default to slug it out. That's because around 90% of Super is in 'default' funds which typically invest between a third and half of their members' money in shares.

Admittedly, Super fund members with default funds don't have the same ability to exit this asset class. But they at least have some degree of comfort knowing there's a fund manager doing something to protect the downside, even if that only means holding fewer shares and being overweight in cash.

Savvy investors who resist the temptation to sell at the bottom also know full well that investing in shares is by nature more volatile than other asset classes, and will eventually bounce.

Admittedly, that's cold comfort given that share prices are sitting pretty much where they were a decade ago — which is still 30% below their 2007 record high.

Don't miss out on market rallies

However, there's sufficient evidence to argue convincingly that shares have consistently outperformed all other asset classes over time. There's also sufficient evidence to suggest that being out of the market even for short amounts of time, increases the chance of missing out on gains once markets rally.

The trouble with exiting the share market when you get spooked is that you risk exiting good stocks significantly lower than when you bought them. Admittedly, some form of active share portfolio management is advisable, like systematic portfolio rebalancing.

But there comes a point when too much active management – especially if it's a knee-jerk sell down, based on first the sign of negative news – ceases to add value.

Sceptics who question this should take note that most active (fund) managers around the world actually fail to outperform their benchmark. In fact, given that 27% of institutional money invested around the world is passive, there's clearly a massive disillusionment with active management.

Do fundamentals still stack-up?

Bank stocks in the US serve to illustrate the point. They've been oversold on fear of a recession. But for those who regard another US recession as highly unlikely, the recent sell down in US banks presents an opportunity to buy while valuations are attractive by historical measures.

There's one important litmus test you need to run by any stock before getting caught up in short-term share market hype. When share markets fall, but the fundamentals surrounding a stock you own – or a sector like banking – remain exactly the same, go back to your rationale for buying the stock in the first place.

If you wouldn't buy the stock today, why are you still holding it? 

But if the fundamentals still stack up, you might be better off buying more of that stock – while it's mispriced – than turning a paper loss into a real loss, which may very likely correct within short order.

Of course, there are times when you should sell, but knee-jerk sell downs are seldom the answer.

Admittedly, it's impossible to invest in assets and never incur a loss, and it is better to remove deteriorating stocks, like value-traps. But don't fall into the rut of thinking about selling every single day.

Don't sideline shares

It's equally important to recognise that bear markets don't last forever. The trouble is if you're not invested in the share market when it turns, you risk missing out on the upswing.

Even investors with little or no appetite for risk would be better off with some exposure to direct shares, to offset the times – like now – when bank rates struggle to outperform inflation and they end up actually losing money.

That's why Australia's listed bank stocks – with their relatively high dividends – remain attractive, even though share prices have come off significantly in the last few months.

Let's take a look at some compelling reasons why shares as an asset class shouldn't be overlooked.

Liquidity: Listed shares – which provide you with a financial stake in a company – offer you greater flexibility and liquidity than other assets, especially property or bonds.

Equally important, the cost of buying shares is low and the capital requirement is minimal. You can buy a parcel of shares with as little as $500, and then turn your shares back into cash by selling them on the ASX.

Compounding returns: But the single biggest reason for investing in the share market is the potential for capital growth, combined with the power of compounding returns.

Remember, an investment earning 10% annually doubles every 7.2 years.

Admittedly, long-term returns in the 21st century are unlikely to be what they were in the 20th century. Nevertheless, assuming US investing guru Warren Buffet is right – and long-term annualised returns are a more modest 7 percent – you will still double their money every 10 years.

This explains why 55 percent of adult Australians – eight million people – own listed shares, either directly or through managed funds and superannuation.

Outperformance: Despite the volatile nature of share markets, research by Goldman Sachs reveals that they repeatedly outperform other key asset classes over the long-term.

As a case in point, average returns for the 18 year period – 1995 to 2012 – saw listed Australian shares deliver 10.93%, while cash and fixed interest delivered 5.63% and 7.88% respectively.

It's true, different asset classes perform better at different times, depending on market conditions and economic cycles. However, the 'average return' reveals that listed Australian shares returns nearly doubled what cash did over that 18 year period.

Nothing princely about cash: Interestingly, the Goldman Sachs figures also show that cash has never been the top performing asset class over the same time frame.

Indeed, there are shorter periods when cash and bonds have outperformed shares. But over the longer haul, history shows that shares have delivered better returns, especially when tax benefits are factored in.

Don't forget dividends and imputations: Adding to your after-tax position are dividend imputations, which is another tax benefit exclusive to shares.

Assuming a listed company has already paid tax on its profits, you will receive a tax credit up to the corporate rate when these profits are distributed to shareholders. However, there may be a shortfall if an investor's personal tax rate is higher.

Caveat emptor

Like all asset classes, investing in the share market isn't without risks.

But according to Warren Buffet, a company's share price should eventually reflect the 'intrinsic value' (IV) of the underlying business, and with the big four banks now trading at significant discounts to their IV, now might be a more opportune time to buy rather than sell.

Seek advice

Given that past performance is no guarantee of future returns, you should seek professional advice before selling or buying stocks on share market.