Is it time to give up on equities?

James Daley asks if the stock market is ever the right option for private investors

(EPA)

Ask a financial adviser how you should save for the long term, and they'll almost certainly tell you to put some money into the stock market. Over the past 50 years, they'll say, stocks and shares have far outperformed all other mainstream investment classes, in spite of their ups and downs. If you're young and saving for a pension, you shouldn't hesitate.

But such logic has been harder to swallow in recent weeks as markets shed one-third of their value. Investors, only just over the trauma of the 2000-03 bear market, have been burnt again.

If it weren't for the magic of dividend payments, an investor who put £1,000 into a FTSE 100 tracker fund 10 years ago would now be sitting on less money than they started with. Even with dividends, the £1,000 would only have grown to about £3,600; less than you'd have earned putting your money into a regular savings account. And count yourself lucky you didn't invest in Japan: a £1,000 lump sum invested in the Nikkei 225 index 15 years ago would now be worth about £630, even after dividends.

So is it time to question the conventional wisdom that equities are best over the long term? And if equities aren't the place to put your money, what should you do with it?

Sell, sell, sell

John Ralfe, an independent pension consultant, decided seven years ago to sell all the equities in the pension scheme of the high-street retailer Boots, moving the entire £2.3bn fund into bonds. Ralfe maintains this was not a call on the direction of the equity markets (although it turned out to be very well-timed), and he'd taken the decision because the fund was taking on far too much risk by keeping three-quarters of it invested in stocks and shares.

Before Ralfe's arrival, Boots' pension scheme was caught in the conventional wisdom that equities must play a part in any long-term pension investing. And it is this wisdom that Ralfe believes many private individuals are swept up in today.

"There's a whole industry devoted to encouraging the cult of equities," he says. "And this says that the longer you hold equities, the lower the risk of underperforming [other asset classes]. But we need to look at how we are measuring that risk."

Ralfe says financial advisers often point out that equities have outperformed bonds and cash over the past 20, 50 and even 100 years, but these statements are based on historical data that cannot predict the future. In Japan, markets hit a 26-year low this week. Economists and analysts now have many explanations for Japan's troubles, but no one was predicting it was headed for a 20-year bear market when it peaked at the end of the 1980s.

Similarly, few foresaw the credit crisis we're now engulfed in. And, while there are good reasons why Britain's stock markets will recover, there remains the possibility that returns will remain poor for years to come.

Ralfe stresses that he's not advising investors to steer clear of equities; they should put their money wherever they want – as long as they understand the risk. For those averse to stock-market risk, he says the alternative is index-linked gilts (government bonds), backed by the UK government and guaranteed to pay a return above inflation. Most advisers would put low-risk clients into corporate bonds, but the credit crisis has shown that even companies with cast-iron credit ratings can go bust. The UK government is highly unlikely to collapse.

Although it's possible to buy gilts directly from the government if you're an advanced investor (see www.dmo.gov.uk), an easier alternative for regular investors is to buy National Savings & Investments' Index-linked Savings Certificates, which currently promise to pay 1 per cent above the rate of inflation and are exempt from tax. You have to tie your money up for at least three years, but in the current climate, they're an attractive option. (Visit www.nsandi.com for details).

Another way to invest in gilts is to buy a UK gilt fund. There are charges, but you may make a slightly better return, as the fund managers trade the gilts to try to maximise the fund's value. Buy these through a stockbroker or a fund supermarket such as Fundsnetwork ( www.fundsnetwork.co.uk).

The only other low-risk option is the bank. But when inflation rises – as in recent months – cash savings rates struggle to keep pace with inflation, so your money is losing value. And, while many people rely on property for their pensions, house prices are in freefall and may pose as much risk as equities.

Once in a lifetime opportunity

Fund managers have been trumpeting that this is now a once in a lifetime equities buying opportunity. The sell-off, they say, has been a lunatic over-reaction, pushing prices of quality companies well below their true value. Although consumers have seen thousands of pounds wiped off pensions and savings, equities will recover, and they remain the best place to save for your retirement if you take a view of 10 years or more.

"I believe that what's happened in the last 100 days is a gross dislocation from reality," says Alan Steel of the financial advisers Alan Steel Asset Management. "I can't believe that all the people in the Far East, emerging markets, China and India are happy to go like genies back into the bottle. The global boom is not over."

Steel makes the case that such countries still have huge growth potential, with a growing middle classes and a big appetite for infrastructure, goods and services. Although the credit crunch has spooked their stock markets and slowed growth in the commodities market, Steel believes these countries will recover and help investors prosper again.

He also says that picking a good fund-manager can gain you a much better return than the index – even in the UK. Neil Woodford, who manages the Invesco Perpetual High Income fund, has returned about 250 per cent over the past 10 years – well above the market's return.

Tom McPhail, head of pensions research at Hargreaves Lansdown, the financial adviser and stockbroker, takes a similar view. He believes investors don't have many other choices. "Unless the model is fundamentally broken, equities should deliver the best returns in the long run," he says. "If you don't agree with that, then where do you turn? You could ride out the next 20 years in bonds and cash and maybe end up just beating inflation."

For the pessimistic, McPhail has a novel solution to retirement planning: "Have lots of children, throw all your money into a pension fund for them, and hopefully, with the money invested for 60 years, they'll be well provided for. Then, when you reach old age, you can ask them to look after you."

If you choose equities because you believe in the wealth-generating possibilities of the capitalist system, fair enough – but understand that if you're wrong, you may have to work longer or accept a lower retirement income. Do get professional advice – but make sure you understand what's recommended. To find a local financial adviser, see www.unbiased.co.uk.