Don't panic: the world isn't ending

The headlines may be grim. The UK may well be headed for recession.

But, if you think the present situation with the economy and the stock market is bad, you ain't seen nuthin'.

I have seen the end of the world. It was in the 1970s, when we had a stock market crash, a property crash, major banks in trouble and the rest of it. And when I say crash I mean a crash, not the fleabite we are experiencing now so far at least. The predecessor to the FTSE 100 index, the FT-30 share index, sank from a peak of 543 points in 1972 to a low of 146 points in 1975, a level not far off that when war broke out in 1939.

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But the world didn't end. And in fact, things have been pretty good over the past 35 years for long-term equity investors. And you didn't even have to get in at the bottom of the bear market or anywhere near it to have done handsomely.

Small investors pay far too much attention to what is going on around them, financially speaking - or at least to the version of it portrayed by the media, on bulletin boards, down the pub and so on. Commentators feel compelled to give reasons for every little movement of the market or a share. But in most cases, the movements are just the result of noise - the price fluctuations created by people trading. It takes an effort to stand apart from all this, but that's exactly what long-term investors should do if they want to build a successful portfolio.

I believe the best approach for most investors is the high-yield portfolio (HYP) method. This is a buy-and-hold-forever strategy. It involves building a portfolio of 15-20 big-cap shares, diversified across a range of sectors. The main goal is to derive a growing dividend income over the years. I avoid trading, so that investors are barely concerned with capital fluctuations. Over the years there's plenty of mandatory corporate activity anyway from bids and the like, which is usually quite profitable.

To hold forever requires either ignoring the minutiae of the financial news, or if you can't do that, being able to ignore it and not be panicked into taking action or worrying. Most news stories will make no difference in the long run to your shares. But at the time, they appear to have far more gravitas than they merit. It is this illusion of importance that the long-term investor must fight.

I've actually seen someone comment very recently on the bulletin board of a well known financial website that "this time it's different", referring to the current bear market. At first I thought they were being ironic. But on reading the message, I realised they were serious and gave all sorts of reasons why they really believed that "it's different this time".

People have a need to give reasons to justify their worldviews, and it's always possible to do so. But a lot of people have said "this time it's different" before and they're always wrong. During the tech boom, there were plenty of investors just bursting to tell you all about the "new economy", and why astronomic share valuations of otherwise worthless businesses were justified, while the stock of profitable old economy' companies drifted.

We all know how that one turned out. And this time it's not different either.

Market movements result from human nature, particularly those substantial swings driven by large fear or greed. So until human nature changes - don't hold your breath - bull and bear markets will be with us, driven not by fundamentals in the main, but by emotion. When people feel good, the sky's the limit. When they feel sick, there's no telling how far the market can sink. Both cases overstate the true underlying nature of the scene.

Back when the 9/11 terrorist attacks occurred in 2001, the market fell drastically. You might understand connected shares falling, such as airlines and insurance, but why the whole market? One of my sons noticed that a share he'd traded in the past fell substantially, a delivery-only pizza business. How could 9/11 possibly affect their business prospects? It couldn't. Nothing had changed fundamentally from one day to the next for the company - yet suddenly it was a fair bit cheaper. The real reason was not that 9/11 would impact directly on most companies' profits, but that shares as a whole were seen after the fact as riskier. Yet not all of them were, of course. The sell-off was down to fear, not anything real. Again, the world didn't end.

I've seen it so many times before. Yet the interesting thing is that many people don't seem to learn from their experiences in this regard. When you think that, in general, we do learn many things from experience as a child you won't stick your hand in a fire twice it's even more remarkable.

My answer is to advise investors to back off from all this. Let others be affected by news and gossip, and be drawn into bull-market bubbles and bear-market panic selling. Holding throughout is the way to go for many investors.

But you can't just buy and hold any shares. You must have a systematic logical approach. I say stick with big caps and diversify across sectors to spread the risks. Then buy cheap, as indicated by dividend yield, which tells you not only about relative cheapness, but also how much cash income to expect from dividends.

I'm not a market timer. I don't believe in it. But that said, I think the current bear market is a great time to be buying depressed high-yield shares for very long-term income. Shares can go much lower, of course, but I take no view of what might happen, something I'm very pleased to acknowledge. Don't ask me if the shares I select for my portfolios will go up or down in the short term. My view is that as long as you have the money to invest, you may as well buy now, and that applies whenever "now" happens to be.

It doesn't matter what happens in the short term, because in the HYP approach, you don't buy the shares with the intention of selling a bit later at a profit. You are above such crass and risky considerations. Leave that to other investors, most of whom will lose or make very little on balance over time.

My approach says buy shares purely to derive a long-term dividend income from them and don't sell them. Dividends are far less volatile than capital values over time. If you look at the dividend streams of most big caps over a long period, then the growth trend is unmistakeable. According to Fidelity International, since 1965, UK dividend payments have increased each year in all but five years. Most of the time except in the mid-70s - the increases outstripped inflation too.

So going for long-term income is way less risky than trying to make short-term gains. And it relieves you of having to follow your shares all the time as well.

Buy then relax. It's that simple.

Find out more about Stephen Bland's high-yield portfolio strategy, and his email investment service, The Dividend Letter.