History shows excessive optimism rather than wars precedes sharp falls in investment returns, and advisers must take this on board, a top Cambridge economist says.
Speaking at the annual Science of Retirement Conference in London today, Professor Elroy Dimson said the most extreme economic downturns are preceded by blind optimism.
Dimson, who chairs the Centre for Endowment Asset Management at Cambridge Judge Business School, gave advisers a run through of how certain asset classes have performed since 1900.
Dimson is known for producing the annual Dimson-Marsh-Staunton database that tracks how equities have performed relative to government bonds over that period.
The countries in the DMS database represent 98 per cent of the world’s equity market performance for every year since 1900.
It shows, for instance, that the UK, which accounted for 25 per cent of the equity market at the beginning of the 20th century, has fallen to 6 per cent as of 2018.
Meanwhile the US grew from 15 per cent to 56 per cent over the same period with American stocks giving the greatest returns for investors since 1900.
Dimson says: “It is not dangerous times like war which hurt investment returns but when people are overly optimistic. What happens is investors believe risk is limited but suddenly change their minds and there is a more extreme correction.
“The downside to being optimistic is that it stops you being realistic. Once you are convinced you will get a good return things can turn as mother nature can be unkind.
“How do you mitigate that? The historical real rate of return on equity is 5 per cent, so last century equities triumphed. But concentrating a portfolio has considerable dangers.
“The story of diversification is a powerful one. We are in a tough world and it is going to get tougher still.”