The number 1 lesson from market history

What is the single most important lesson from market history?

It is often assumed that to be a successful investor you need to be an expert in economics. In fact, a knowledge of history, particularly the history of the financial markets, is far more useful.

In this video, Professor Russell Napier, financial historian and founder of The Library of Mistakes in Edinburgh, shares the one standout lesson that financial history teaches us. He points to a book he regards as essential reading: "Triumph of the Optimists" by Elroy Dimson, Paul Marsh and Mike Staunton, which maps the historical returns from equities, bonds and cash over the entire twentieth century. That long sweep of data allows investors to work out what counts as a reasonable return and what does not, in other words, what you can realistically expect from a market and what you cannot. The clearest conclusion, Napier argues, is the need to diversify, and not just between equity markets but across asset classes.

You'll also learn why taking a genuinely long-term view matters so much. New investors today may be investing for 50 years or more, yet most people, when they hear "long term," think in terms of four or five years, perhaps eight or nine at a stretch. Professor Napier explains why the real long term is closer to eighteen years, noting that, historically, there has never been an eighteen year period in which US equities failed to deliver a positive real return with dividends reinvested. The danger lies in the prolonged stretches when equities do not deliver, which is why understanding what "long term" truly means is so important.

The takeaway: all investing involves a degree of risk, but if you diversify across asset classes and think in genuinely long-term horizons, you can afford to invest with confidence.

Chapters / Key points

• Why history matters more than economics for investors
• Professor Russell Napier and The Library of Mistakes
• Why "Triumph of the Optimists" is essential reading
• What a century of market data reveals about reasonable returns
• Why diversifying across asset classes, not just markets, is vital
• What "long term" really means for investors (and why it's eighteen years)
• Why misunderstanding the long term is so dangerous
• How diversification and patience let you invest with confidence

Transcript

The number 1 lesson from market history

RP: It's often assumed that to be a successful investor, you need to be an expert in economics. In fact, far more useful is a knowledge of history, particularly the history of the financial markets.

Professor Russell Napier runs a financial history library in Edinburgh called The Library of Mistakes. For him, there's one standout lesson that financial history teaches us.

RN: People sometimes ask me, "What is the number one book to read on finance?" and it's a book by Elroy Dimson, and Marsh and Staunton, called "Triumph of the Optimists." All that book is, and it's a rather expensive book, we have a copy here for anyone who wants to come and read it, is a roadmap of the historical returns from equities, bonds, and cash over a very prolonged period of time; and it allows you to work out what has been a reasonable return and an unreasonable return.

In other words, what you can expect from a market and what you can't expect from a market. I think the simple answer from all of that data is that you do need to diversify; and not just between equity markets but between asset classes.

RP: That book, "Triumph of the Optimists," charts financial returns over the entire twentieth century. No one invests quite that long, but new investors today may be investing for at least 50 years. You need to take a long-term view.

RN: All investors need to know what the long term is. That's it. That's what they need to know. Once they know what the long term is, then they can adjust accordingly. The long term, I think, is eighteen years. I think, on the whole, for US equities, there's never been a period of eighteen years when you didn't get a positive real return with dividends reinvested.

The problem, I think, is that most people, when you say long term, think four or five. Some might even stretch to eight or nine, but there have been these very prolonged periods when equities have not delivered your positive real returns.

RP: All investing involves a degree of risk. But if you diversify and think long term, you can afford to invest with confidence.