Chapter 5. Is My Investment Safe?

Imagine walking into a bookmakers and finding that most horses won, often at pretty decent odds. Or visiting a casino where there is no zero on the roulette wheel and the dealer’s blackjack cards are dealt face up.

Welcome to the world of the stock market.

Yes, it can seem a bit of a gamble picking shares but it is one where the odds are stacked in favour of the punters, where the majority walk out winners instead of losers.

Shares do arguably represent a riskier investment than putting your money into a savings account with a fixed rate of interest, but the risk is much less than you think – and the potential rewards are much greater.

During the credit crunch, some savings accounts looked quite risky. That is why queues formed outside Northern Rock as worried savers rushed to withdraw their cash, why the government of the Republic of Ireland stepped in to guarantee all savings in Irish banks, and why the UK government offered similar guarantees up to a set limit. Banks in Iceland did in fact go bust.

Sure, if you put away a large enough sum of money into a savings account you might be able to live off the interest – for now. But your savings are being eaten away all the time by inflation. As the years go by, that fixed rate of interest is worth less and less while your lump sum never increases.

By contrast, dividends on shares generally rise over the years to offset inflation and, over time, most shares increase in value.

Minimising risk

Every investor needs a well-balanced portfolio of about 10–12 shares spread across different sectors: such as a bank, a housebuilder, a power company, a transport provider and so on. So if one share suffers, the likelihood is that others will compensate.

Yes, it is possible for the whole market to tumble, as it did between 2000 and 2003 and again in 2008, but even if you bought right at the top of the market in March 2000 or in 2007 and clung on obstinately, you would still probably be better off today than if you had let your cash dwindle away in the bank or building society.

In that sense, investing in the stock market is safer than a savings account. And you can decide for yourself how much risk you want to take. Do you go for big solid household names or pick out up-and-coming young companies? By learning how the market operates and how to avoid pitfalls you can learn to take sensible decisions to create a portfolio that suits you.

It is true that there are unscrupulous people in the stock market, as there are in any walk of life. Shares often move before a big announcement, as those in the know buy or sell before the rest of the market catches on. Insider trading is virtually impossible to stamp out entirely.

However, there are three different bodies policing UK stock market investments with considerable effect:

· the London Stock Exchange

· the Takeover Panel

· the Financial Conduct Authority.

Let’s look at these three in some more detail.

London Stock Exchange (LSE)

First, there is the London Stock Exchange. It has strict rules on when directors can buy or sell shares in their own company and on when they must alert the market to a change in profit expectations. All formal announcements on matters such as takeovers and mergers, results and major transactions, must be made publicly at the earliest opportunity. In practice, such statements are almost invariably issued through the London Stock Exchange itself.

We shall be looking more closely at the role of the LSE in the next chapter.

Takeover Panel

Then there is the Takeover Panel, whose job is to ensure fair play not only in takeovers but also in mergers and when large investors take major stakes in a company. The Panel oversees the Takeover Code, which sets a timetable for bids, decides when control has passed to a new owner and determines what the various parties to a bid can say and do.

Above all, the Panel ensures as far as possible that all shareholders great and small must be treated equally in a takeover. The Panel has, over the years, tightened the rules on takeovers to level out the playing field and is not afraid to take on big guns in the financial world to do so. It has built a reputation for being fair to all participants and for enforcing the rules where necessary.

We shall look in more detail at takeovers in Part Five.

Financial Conduct Authority (FCA)

In April 2013, the Financial Services Authority, which until then had overall responsibility for regulating the entire financial services sector, including stock market dealings, was divided in two:

· the Prudential Regulation Authority, which is part of the Bank of England, took charge of banking supervision

· the Financial Conduct Authority became the consumer watchdog.

Despite the work of these three bodies, in the final resort it is up to you to go into stock market investing with your eyes open, to do your homework and to know what you are doing. Do not expect a fairy godmother to step forward and make up your losses. After all, you expect to pocket any gains you make.

Shares versus other investments

Other forms of investment apart from savings accounts can make you money. Gold has on occasion proved a good short-term bet. Rare stamps, paintings, coins, wine, even carpets have their day. Indeed, in the past tulip bulbs presented one of Europe’s most notorious boom and bust stories.

Cryptocurrencies enjoyed a stellar performance in 2017, led by Bitcoin, which traded just below $1,000 at the start of the year and peaked at $19,000 on 17 December. Performance in 2018 has been less stellar: at the time of going to press, Bitcoin stood at $6,750.

As with your house, with shares, with the contents of your attic, what you own is worth what someone else is prepared to pay. And if the price of a case of 1996 Latour or an 1882 British Empire Orange stamp starts to motor, then other investors are sucked in until the bubble bursts.

Stocks, too, can be subject to the vagaries of passing whims, as first biotechs and then computer technology shares have demonstrated in recent decades. The big safeguard with shares is that unless you take silly risks on ephemeral fancies you are buying a stake in something that has a real value of its own, in addition to the price that another investor is prepared to pay for it. For as long as the goods the company makes, or the services it provides, have value, the company and its shares have intrinsic value.

Shares are linked to the health of the UK and overseas economies. The amount of goods and services sold rises as economies grow, and falls in recessions. The fact is that economies around the world spend longer growing than contracting. The world is, overall, a richer place than it was ten, 20, 50 or 100 years ago.

By investing in shares, you take your stake in the increasing wealth of the UK and the world.

If inflation is only 2.5%, then £10,000 falls in value to £9,750 over the course of just one year and to £8,810 in five years. If inflation is 5%, then your £10,000 is halved in less than 15 years. So you have to constantly top up your savings account out of the interest you receive, just to maintain the real value of your savings. It is like running to stand still.

Shares on average not only keep pace with inflation, they provide you with an income as well.

There have been periods when shares have fallen over several months, even over years. The FTSE lost three quarters of its value in 1973–74. In 2000 we launched on a decline that was not quite so steep – the FTSE 100 lost over half its value – but it was a much longer downward grind, lasting three years.

Most recently, shares again fell heavily throughout 2008 and into the early part of 2009 in the wake of the global financial crisis.

However, shares gain in value in far more years than they fall.

Shares v gold

Chart 1: UK stock market compared to gold

The chart covers nearly 40 years, with the price of gold and the FTSE All-Share index both rebased to a value of 100 in 1980. The price of gold, which is normally quoted in US dollars, has been converted into pounds sterling to give a fair comparison.

As the gold price subsided for 20 (yes, 20!) years, shares powered ahead, opening up a massive gap over gold. Despite the much heralded surge in the price of gold between the year 2000 and 2011, and despite two serious setbacks on the stock market, all gold had done in a dozen years was to partly close the gap.

And that does not take into account the fact that gold produces no income while shareholders had 40 years of steadily rising dividends.

Since 2011, gold has fallen back in value while stock markets around the world, including London, powered to new highs.

Shares v property

The one other alternative form of investment that combines income with rising values is property. Over the past decade there has been a boom in buy-to-let – purchasing houses to rent out. As with shares, values can fall as well as rise, but they rise more years than they fall.

However, property involves administration and maintenance. While you can decline to commit more cash to your share portfolio when money is tight, you cannot ignore a leaky roof whether you have the cash to fix it or not.

You are also at the mercy of the chancellor of the exchequer. During his stint in that office, George Osborne attempted to free up flats and houses for homebuyers by removing the right of landlords to claim tax relief on mortgages and by slapping a 3% stamp duty surcharge on buyers who already own another property.

Insider trading

The use of privileged information to gain an advantage in the stock market is pernicious and will be impossible to stamp out entirely as long as human beings are inclined to commit the seven deadly sins, one of which is greed.

Too many people within a company or among its advisers are party to information ahead of an announcement of events, such as results or a takeover bid, for the authorities to ascertain where any leak came from – especially when the culprits give hints to friends and relatives who do the actual trading.

The London Stock Exchange routinely investigates any unusual or sharp movements in share prices and any surge in trading volume, especially in companies that subsequently reveal price-sensitive information.

While this is a matter for concern, we need to get it in proportion. Unless you sold shares just before a takeover approach was revealed, or intended to buy shares but were put off by a share price increase, you have not been adversely affected. Only those who paid over the odds for their shares, or who missed out on a short-term profit, have cause to complain.

If you already held the shares, you benefited from the share price increase.

Because companies are obliged to issue a public statement when there is a sharp movement in their share price, we are talking about a very short time frame, possibly just the first hour of a day’s trading when most private investors are inactive. Once the news is out in the open, the shares would rise anyway.

The Takeover Code

Companies that have received a takeover approach are expected to do the decent thing and inform the market as soon as there is any reasonable prospect of a firm offer emerging.

However, the Takeover Code explicitly acknowledges the obvious fact that a company may not be aware that it is being eyed up as a bid target and cannot be expected to disclose something it does not know about yet.

Nor do companies need to reveal every single conversation they have with a potential bidder. One might argue that all approaches should be revealed immediately but that would be quite impracticable and would do more harm than good.

Many approaches come to nothing, so there is no point in boosting bid hopes prematurely. As it is, many approaches are rejected without being translated into a firm proposal – or the potential bidder decides it is not worth pressing its case.

However, target companies are required to do the decent thing and own up if their share price starts to rise while secret talks are going on, so as to nip any insider trading in the bud. Changes to the Takeover Code in 2011 increased the onus on target companies to confirm or deny rumours.

Insider trading can also happen ahead of the announcement of better or worse than expected company results. Here the authorities have been much more successful in stamping out the insider trading that was once widespread.

Companies have become far more responsible in keeping investors informed of any changes in trading conditions and they are certainly required to alert the stock market to any substantial changes in profit expectations, whether for better or worse.

We shall look at takeovers in more detail in Part Five.

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