Rational Advisor

The article below is from the Scotsman, a Scottish based newspaper

Despite the uncertainty, regular investment is still the safest way to save

SCRUTINEER

By Bill Jamieson

SELDOM has the gulf been wider than it now is between the spasms of apocalyptic gloom in financial markets and the day-to-day reality of business life. The mood in the real economy is indeed downbeat and apprehensive. But it is nothing on the scale suggested by the recent gyrations in stock markets. The FTSE 100 index fell just 33 points last week, but this masks some of the most violent swings in 20 years, with the index having traversed a 635-point trading range, a move of almost 12 per cent

The question every investor now faces is whether we are experiencing a “conventional” – if notably turbulent – cyclical downswing, or some massive, epochal breakdown in the financial system. Because a recession we can live with – downturns in the business cycle are hard-wired into business life and culture. Interest rates are cut, fiscal policy relaxed, and after a painful interval of re-adjustment, the cycles turns up again.

Interestingly, last week saw some sharp rises in shares in the UK commercial sector on the view that the falls have been overdone. British Land rallied 9.2 per cent, Hammerson 12 per cent. House building companies also enjoyed a rally. And in America, there are signs that an end to the slump in the housing market may now be in sight.

But a recurring undertone in the massive sell-offs of recent weeks is that the global credit crisis is getting worse and that this is more than a periodic shift in the market cycle. The violence of the sell-offs, both in speed and scale, suggest a structural problem at the heart of today’s capital markets and the dramatic growth of derivative credit products over the past 20 years. This view is echoed in remarks such as those of veteran hedge fund manager George Soros, who said recently: “This is not a normal crisis, but the end of an era.”

First, sub-prime mortgages, then credit derivatives, then worries over monolines, or credit insurers, and now, late last Friday, talk of hedge funds being in trouble: the bolder the action, the more the problem seems to spread and grow. US banks are still holding more than $230 billion of high-risk loans and bonds on their balance sheets, while the tally of bank write-downs related to sub-prime loans has already crossed $100bn. More huge write-downs are feared.

Lower interest rates, while they certainly help cushion the impact on household budgets and consumers, do not really address the structural problems that have arisen and the loss of trust in the sophisticated financial instruments that lay at the heart of the credit and housing boom of recent years. That is why, despite the conventional policy responses by the Federal Reserve and the US government, the Dow has failed to rally.

Faced with this huge turbulence in markets, millions of pension fund and long-term savers feel utterly powerless. Savings, built up over a lifetime, much of them out of after-tax income, are slashed by several percentage points in one day. And for those coming up for retirement, these dramatic gyrations in markets are particularly worrying, cutting through the most careful financial planning.

Last week, the former UK chancellor, Nigel Lawson, pronounced on BBC’s Newsnight programme to the effect that we have had a huge borrowing binge and now we must live with the hangover. In the studio, heads nodded gravely in agreement. Mine didn’t. The people suffering the hangover are the prudent savers, while the borrowers – the people who went on the binge – are not suffering a hangover at all. In fact, central banks have now poured neat alcohol into the party punchbowl.

Yet the calls now come thick and fast for households to cut borrowing and boost saving. Mervyn King, the Bank of England governor, took up this theme in his speech last week. Such calls are scarcely credible when you consider how easy it became for households to take on huge debt while pension funds suffered tax raids and ISA savings plans were made less attractive. Inheritance tax is the final insult. Until we stop penalising savers, we will not effect the change in culture required to get us out of the debt mess.

What, in the meantime, is the private investor to do? There is no better strategy than to keep one’s nest egg spread over different asset classes – cash, fixed interest, and property as well as shares – and to feed regular amounts into broadly-based funds over a long period. This is because, over time, equities have delivered superior returns to those from a building society or gilt-edged stock.

Regular investment can ride out the storms, and can show outstanding growth when income is automatically re-invested. But these investments have to be balanced by holdings in other assets to help reduce overall volatility and prevent unwanted shocks as retirement approaches.

In the meantime, we should allow time for the rate cuts and (in America) the fiscal stimulus to work. We may not know until the second half of the year how extensive this crisis really is. For the moment, sit tight, and keep the seat belts on.

http://business.scotsman.com/business/Despite-the-uncertainty-regular-investment.3715824.jp

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