With current markets especially volatile, how does the long-term investor maintain a positive outlook, asks Alan Durrant?

    I recently met with a good friend for dinner. Having discussed fishing, football and cars, the topic switched to investment. Even though he isn't involved in financial markets, he keeps a keen eye on markets as he owns a substantial portfolio. He quite rightly observed that the current markets are especially volatile and apparently directionless. He questioned how the Dow can fall 1000 points in minutes and be down only 100 points a few short hours later. He asked how markets can rationally be down 2% on Monday, up 2% on Tuesday, down 2% on Wednesday. "It just doesn't make sense," he argued. "The world doesn't get better and worse so quickly. Why do share prices get whip-sawed like this and what comfort does a long-term investor have that their nerve will be rewarded?"

    I told him that in truth, few fund managers claim to be able to predict short-term movements. That is why we advocate long-term investment horizons. "Ok", he asked. "Why are you so sure of the long term?"

    For someone investing as far back as 1999, the FTSE All Share has now delivered practically zero capital return.

    For me, the starting point for this has to be looking at equity income. We all know that there is an enormous difference between the total returns delivered by equities and the capital returns. For someone investing as far back as 1999, the FTSE All Share has now delivered practically zero capital return. That's a decade and a half and still counting. When reinvested income is considered, the picture is far brighter with a total return of around 70%. No wonder Einstein was reported as saying that compounding was the eighth wonder of the world...

    Today the FTSE All Share yields 3.7%. The FTSE 100 yields more than that and there are plenty of income-focused funds offering yields in excess of 4.5% For long-term investors that is a very strong starting point when assessing their likely future returns. If nothing else happens to their income or capital, this is a decent return and better than that offered by cash or government bonds.

    However, we know that these yields aren't likely to remain unmolested. We hope for dividend growth. We caution against dividend cuts. We are aware that the UK market has a high yield (albeit that a number of emerging markets are now offering similar yields) but also that the UK's yield is concentrated in a relatively small number of mega-dividend providers.

    We have enjoyed very healthy dividend growth in the UK over the last few years as companies have finally accepted that they don't need to hoard cash to protect themselves from another credit crunch. This year has been somewhat less good. Eight of the FTSE 100 companies have cut their dividends this year. The supermarkets made headlines when they cut but Tullow Oil, Glencore, Antofagasta and Centrica have also done so. According to one equity income fund manager, these dividend cuts have amounted to £3.7bn of cash not received by investors. Viewed another way, this is the equivalent to a FTSE 100 company going bust entirely.

    So what does this mean for short- and long-term investors?  As a long-term investor I am happy to ignore the short-term see-sawing so long as I am happy to bank 4% per annum whilst I am waiting for dividend growth to come through. Indeed, I am even willing to top-up on days the screen turns red as I am buying more income for the same investment. However, we remain on full alert for signs that the promised dividends are false ones. Oil below $50 will be placing strains on the oil majors. Glaxo's balance sheet looks sound for now but it really needs to turn research into profits over the coming years. The banks are beginning to pay dividends again but regulators will remain ever watchful that shareholders aren't put before the safety of the bank. There are some mouth-watering dividends among the miners but some seem almost certain to cut.

    So my advice to my friend was this; so long as the general direction of dividends over the coming years is at worst flat, you can safely hold a portfolio of equities and be comfortable that you will be generating real returns. If dividends rise, even by modest amounts, then you should enjoy capital growth too so ignore the short-term noise.

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