Clients have different attitudes towards risk and equities are clearly a more volatile asset class than bonds or cash. However, even on a risk-adjusted basis, equities have consistently delivered a higher return over the long run and also offered protection against inflation. The key aspect is the investment horizon, which must be sufficiently distant to allow equities to generate superior returns. It has been very rare for cash or bonds to outperform equities over a 10 year period and, over longer periods, equities have always outperformed handsomely.
Given the higher short-term volatility of equities, it is tempting to say that one should be able to switch between the asset classes in order to maximise returns. The potential benefits of market timing are clear but, in practice, are extremely hard to achieve. Such a strategy also incurs unnecessary risks as, historically, even if investors buy at stockmarket peaks, equities have eventually outperformed cash and bonds by a wide margin.
As the key months of outperformance by equities very often follow periods of significant underperformance, investor psychology is such that it is extremely unlikely that many people would buy at these times. In the long run, good performance is more likely to be generated by agreeing the right asset allocation for a given level of risk, maintaining that position through the difficult times, and trying to add some value through stock selection. For the long-term investor, there is much more risk in attempting to trade in and out of the markets than remaining fully invested.