I spent 40 years beating the stock market – here’s how you can do it too

Inflation eats away at the value of cash savings, eroding what is called money’s “purchasing power”.

So investors talk about needing savings to deliver “real returns”, which is just a way to describe returns after taking account of the effects of inflation.

While it’s sensible to have some savings in cash in case you have a sudden need for money (if the roof blows off, say), over very long periods of time – and we have data going back over 120 years in Britain – cash has delivered a return of less than 1pc a year in real terms.

Shares and bonds

This is why savers invest in shares and bonds. Bonds are typically less risky than shares so we’ll look at them first.

If you buy bonds issued by the Government or a company, you are lending it money, which it will repay after a specified period and on which it will pay interest in the meantime. This is a bit like depositing money with a bank, but usually you get a higher interest rate to reflect the risk that the issuer won’t repay the bond at the end of its life, often 10 years.

Once issued, bonds trade on the stock market and their prices rise and fall according to the “yield” – the annual return – demanded by investors. That yield is in turn driven by their perception of future rates of inflation and interest rates.

Company shares, also called “equities”, represent the permanent capital used by companies to establish and grow their business. Unlike bonds, shares are not repaid at a date in the future. If the business is successful, the value of the shares should rise over time.

Crucially, of course, share prices also rise and fall according to investors’ enthusiasm or disenchantment.

Shares in a successful business about which investors are excessively optimistic may trade at such a high price that they will not prove to be a good investment. Companies usually pay dividends to shareholders too, as a reward for providing them with capital.

Since bonds pay a fixed amount of interest and just give you your money back at the end of their life, they are as vulnerable to inflation as cash deposits. Bonds issued by the British government have delivered a real return of about 1.5pc a year over the past 120 years: better than cash but hardly the stuff of riches.

Shares, by contrast, have delivered real returns over the same period of around 5pc a year. This is why so many long-term savings are invested in shares – they provide good returns above the damage done by inflation, preserving and growing the value of your money.

Volatility

Both bond and stock markets can be volatile. For all the expert views you will read forecasting the likely next moves in financial markets – and I’ve written a few in my career – remember that whether markets go up or down in any year is as predictable as tossing a coin for heads or tails.

All you can rely on is the evidence of history that in the long run financial markets will deliver those real returns. Any savings in markets must be for the long term: a minimum of five to seven years, and ideally for much longer.

During my time as a fund manager I have experienced at least seven stock market falls of more than 20pc – the traditional definition of a “bear” or falling market.

I’ve lived through two grinding three-year-long bear markets, or three consecutive years of falling share prices. But eventually panics subside, recessions end, animal spirits revive and markets go up again.

This is also why regular monthly savings in the stock market – whether via individual shares or funds – makes sense.

I have done so for decades through a simple standing order. It means when markets are low your investment buys more and when markets are strong you buy less. This smooths out the volatility in stock markets.

Shares or funds? Passive or active?

Investing directly in the shares of individual companies can be great fun and very rewarding financially. But keeping on top of the changing fortunes of those companies is immensely time-consuming. I’ve done it professionally for nearly 40 years – believe me!

Here’s an example. I was a happy shareholder in Tesco for years but sold out when it decided to start an operation in America – a notorious graveyard for British retailers. Five years and a few billion pounds of losses later, it gave up and I invested again. But the shares had fallen by 60pc in the meantime.

This is why most private savers buy funds managed by professional investors, although they will pay a fee for doing so. Many people use “passive” funds, which simply try to match the returns from a broad market index, such as the FTSE 100, and have much lower fees than “active” funds managed by people like me.

This can be sensible but my objection is that an index represents the market’s favourites of the moment. You will have more invested in today’s stock market darlings when they are the biggest companies and ride them all the way up and all the way down.

Vodafone, for example, was once 10pc of the London stock market and a tracker fund would have had that size of holding. It has been a very sorry 20 years for Vodafone investors since those heady days.

Passive investing has been described as a Soviet system, after the capital allocation process of the former USSR, which gave more money to the biggest state-owned firms rather than to the most successful.

It’s a line I’ve used on various conference platforms, as things didn’t end well for the Soviet Union.

Clearly as an active fund manager I believe one can do better than that and identify companies that are growing or shrinking – or where valuations are too low or too high, as was the case with Vodafone in 2000.

Which funds should you invest in?

You are spoilt for choice – there are far too many. Tracking successful funds takes time, too. After all, fund managers move firms and even retire.

Choose a fund whose performance is consistently solid over one that seems to shoot the lights out – it may be taking too much risk or riding a current fad likely to end in tears.

UK or global? There is merit in investing in both.

The London market is currently cheap and unloved by investors. America accounts for more than half of the “global” stock market, and the US has been outperforming other markets handsomely over the past decade and more.

History suggests that this trend will unwind over time. Japanese shares made up nearly half the global index at the end of the 1980s and had a torrid time for the next 30 years.

I don’t expect the US to repeat the experience of Japan – and obviously it has those dominant IT companies – but valuations reflective of past success aren’t always the best starting point for future growth.

Asia strikes many as a good long-term bet for future growth. Even here, though, investors need to decide if they want exposure to China.

Some Asian funds shun China but may well have significant holdings in Australia, which may not exactly be capturing the Asian growth future you seek. And Japan is such a different market that it is best to use a dedicated specialist manager who focuses exclusively on Japanese investments.

OK, I want to invest. How do I go about it?

It’s quite easy today. There are many online “platforms” on which you can open an account and start investing in shares or funds – Interactive Investor, AJ Bell and Hargreaves Lansdown, to name but three leading firms.

Compare fees and users’ reviews, naturally. Be wary of recommended lists of funds: these may not be the best-performing funds but those that offer the platform the best fees – a practice I think should be banned.

Remember the power of compounding returns from investments: it’s never too late to start investing, so pluck up the courage to take the plunge. And enjoy it!

My most challenging moment as an investor

The global financial crisis of 2008 was the most challenging market environment to live through.

While governments and central banks have almost limitless powers to flood financial markets with money to address panics, we know now that we came within hours of cash machines being unable to dispense money.

While several banks failed, the consequences if Britain’s entire banking system had had to be nationalised hardly bear thinking about.

But shares got so cheap through forced selling by investors who had bought them with borrowed money that I was able to add to positions in good companies such as Next and Burberry at never-to-be-repeated bargain-basement valuation levels.

My fund had its best ever year in 2009 as markets rebounded.