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The importance of taking a five-year view on investments

The stock market never fails to surprise.

Back in November, the Pensions Regulator announced that, for the first time since the 1950s, leading UK pension funds were holding more of their assets in fixed interest stocks than in equities.

Given the mood of caution among many equity investors, such a story might normally have been expected to trigger further weakness in the stock market. Exactly the opposite happened.

Perhaps assisted by the US presidential election delivering a clear result, UK equities shrugged off the Pension Regulator's update and set off on a mini-rally.

The FTSE All Share Index subsequently posted a 12.3% total return for 2012, ahead of the 2.7% return from UK Treasury stocks.

The rally has continued, with the FTSE 100 clearing the psychologically important 6000 level in January for the first time since July 2011, and already this month the index has been hitting five-year highs above 6300. There is a mood developing that, despite the economic uncertainty, shares have further to run and that the great bull market in bonds is finally running out of steam.

Of course, there is little point trying to make short-term predictions, especially when markets seem to be driven more by the comments and actions of politicians and central bankers than by company news. One must also be wary of over-optimism, although investors could be forgiven for looking at their Isa or personal pension and basking just a little at how much values have increased in recent months.

Welcome though short-term rallies are, what time frame should we use when taking strategic investment decisions?

I am convinced that for the typical private client, five years is an appropriate yardstick. As evidence for this assertion, I dug out the article I wrote for The Herald back in April 2008. Of course, that was the time when economic problems were worsening ahead of the global financial crisis.

I read my article with some nervousness. Had I been complacent about the looming crisis? More importantly, had I dished out hopeless advice? Well, I had clearly not anticipated quite how bad things were going to get: I put my hands up on that one.

However, what I did say back then was that a diligent long-term approach of investing in companies whose strategy was credible and understandable would add value, and that the Asian growth story looked set to continue.

Nearly five years later, and with the global economy wounded but having survived the banking collapse and the sovereign debt crisis, it has been fascinating to assess how markets have performed over the intervening period. In terms of total return from income and capital, and perhaps surprisingly, the FTSE All Share has generated 5.5% per annum. Mid cap and small cap shares did even better.

Overseas markets also did well, with the FTSE World ex UK Index generating an annual return of 6.6%. Investors in bonds did best of all, with Treasury stocks delivering more than 7% per annum, although such outperformance looks unlikely to continue.

Therefore, if you had invested wisely, hung on throughout the crisis, and, crucially, reinvested your income, then you would have done pretty well. Brain power and staying power have been the ideal combination. You have not made a fortune, but your money has grown, and beaten cash. This is what long term investing is all about.

So, when planning your investment strategy, taking a five-year view is a good starting point. You should not be put off from investing now just because equities have done well recently. There are still plenty of opportunities out there, just give them time to perform.

Harry Morgan is director at Thomas Miller Investment in Edinburgh

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