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Last week I examined the performance of the Japanese market over the past 20 years and claimed that although the major indices have declined by around 69% in that time, the experience for long term investors would be substantially better provided even the most basic of principles were applied.
What we must first acknowledge is that the long term investor does not simply buy a bunch of shares at some specific point and then sit on them indefinitely. As income is saved, investors add to positions and build their portfolios. This has the unintended (yet beneficial) effect of dollar cost averaging. I have already written extensively on this, but I do want to remind readers that I don’t advocate dollar cost averaging as a strategy in and of itself. Rather it is an unavoidable consequence of continuing to build a portfolio. A consequence that helps smooth out volatility and reduce the reliance on timing.
Consider the example where an investor has the terrible misfortune of investing $2000 into the Topix Index at the absolute high of the 1989 boom in Japan. However, if this investor continues to add an additional $2000 each and every year after this, their return on investment comes in at -32%. Again, that’s nothing to get excited about, but it does represent a substantial improvement on an otherwise near 70% loss.
Of course to this point, while we have significantly reduced our losses we are nevertheless well and truly in the red. What we have failed to do of course is include dividends and the power of compounding (my favourite topic and the cornerstone of the DividendKey approach). Consider the difference between the Topix and Topix Accumulation Index (which factors in the effect of dividend reinvestment):
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As you can see, even a seemingly low dividend yield of approximately 3.5% per annum can lead to a substantial difference over the long term. Again we still remain in the red, but the losses have nearly halved when dividends have been reinvested. However when you combine the effects of regular additional contributions with dividend reinvestment, something truly remarkable happens.
To continue with our previous example, let’s say that you invest $2000 into the Japanese market at the very height of the bubble. However this time you not only continue to add an additional $2000 each year, but you also reinvest your dividends. Amazingly, even though the Topix index has declined by close to 70% in that time, in this example you are today down only 3.6% on your invested funds! And all of this in a virtually inflation free environment! Essentially, although you have failed to grow your capital, you have nevertheless maintained your wealth, something that you achieved in the worst market of the modern era with nothing more advanced than investing in an index, reinvesting dividends and making regular contributions. Personally, I find that quite amazing.
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What is also amazing is that you have to remember that the Japanese market not only suffered truly horrendous losses following the 1989 high, but of course was also affected by the Global Financial Crisis (in fact, it was hit harder than the US and Australian markets, declining by close to 60% between 2007 and early 2009). As you can see in the chart above, prior to the GFC the portfolio was actually doing very well indeed; at its height enjoying a healthy 69% return on invested funds. Again, this is truly remarkable when you consider that the initial investment was made at the height of the market in 1989.
Additionally, one should also consider the value of diversification into other asset classes and off shore markets. Instead of reinventing the wheel, I will instead direct readers to an excellent article which very clearly demonstrates how Japanese investors could have seen attractive returns by simply investing even a small proportion of funds offshore (take note that this was written back in March when the Japanese market was substantially lower than it is now). Japans Great Depression.
Let me reiterate once again that long term investing does not necessarily mean simply buy and hold, and it does not infer that you must be resign yourself to achieving the market average. As a long term investor I am continually reviewing my positions, reweighting my portfolio and initiating risk mitigation techniques. Furthermore, as I have previously shown, a focus on dividend paying industrial style businesses has historically led to a significant outperformance of the broader market indices. Had we conducted the previous example using a diversified mix of the better Japanese stocks we would have actually seen a very attractive return over the same period. For example over the past 20 years shares in Canon have seen a near five-fold increase in value.
So it is really undeniable that a well managed portfolio of quality industrial style stocks, with dividends reinvested, regular additional contributions, and with even a small amount of funds diversified into offshore markets, would have actually led to very attractive long term returns, and all in an inflation free environment. And that’s even accounting for the fact that you initiated the investment strategy at the worst possible point in history. Truly remarkable.
So in conclusion, cynics should be careful not to quote the Japanese market as an example of why long term investing doesn’t work. Yes, it certainly has been the worst performing advanced market of the modern era, but that hasn’t stopped savvy investors from achieving a healthy return. Simply referring to a long term chart of the Nikkei or Topix as ‘proof’ that long term investing doesn’t work is overly simplistic and ignores the most basic principles of sensible investing. It’s akin to pointing to a plane crash and claiming that air travel is highly dangerous. Very spurious reasoning indeed.
For more information on this style of investing visit www.dividendkey.com!
Make the markets work for you!
Andrew Page
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