One would think that, with over 75 years of reliable stock market data, there would be fewer investors out there hell-bent on trying to hone the art of timing stock markets and more long-term investors adopting the tried and tested buy-and-hold strategy. The well-documented ability of greed, fear and anxiety to wreak all manner of havoc on even the most cautious investor’s portfolio is nothing short of phenomenal. Simply put, when investment decisions to exit and re-enter the markets are driven by human emotions, the results are more often than not sheer disappointment and dismal financial loss. There’s a plethora of incredibly sound reasons why it’s time in the market and not timing the markets that creates real wealth. Let’s examine them.
Trying to time the stock markets is not altogether unlike jumping shopping aisles to find the shortest queue – only to get stuck at the till with the slowest teller whose scanning machine packs up just as you reach the front of the queue. The reality of investment market performance shows that between 80% and 90% of all the returns realized on the stock exchange occur between 2% and 7% of the time. This means if you’re out of the market when stocks start to perform, your portfolio is destined for under-performance. In fact, Nobel laureate William Sharpe’s research found that market timers must be right an incredible 82% of the time just to match the returns realized by buy-and-hold investors.
When considering some of the not-so-conventional methods used by money-hungry market timers to predict market movements, it’s a wonder that so many highly educated and intelligent people still ascribe to this method of creating wealth. Investment gurus such as Warren Buffett, Peter Lunch, Walter Schloss and Shelby Davis have long touted the investment virtues of the buy-and-hold strategy, whereas one would be hard-pressed to find successful market-timers with any worthy investment track-record. Far from using sound financial data, market timers succumb to relying on weather patterns, social science research, historical data, economic theory and an abundance of other not-so-conventional methods in their attempt to create wealth quickly. It’s long being accepted, however, that investment markets are too dynamic and complex to predict with any reliable consistency and that sticking with a long-term investment strategy, whilst reviewing your portfolio regularly, is the most lucrative investment approach.
Three quarters of a century’s worth of data shows that one of the biggest risks of timing the market is potentially missing the markets best performing cycles. And with investment markets achieving most of its gains in short bursts, missing the market highs whilst trying to time the market is relatively easy to do. Frighteningly, if you missed the 90 best-performing days of the stock market from 1963 to 2004 (a period of 41 years) your average return would have dropped from 11% (on a buy-and-hold strategy) to 3%. In fact, two-thirds of the markets’ gain during these four decades happened in fewer than 1% of its trading days, which certainly doesn’t leave much room for error.
Let’s have a look at an example of the effects of timing the market. Columns A, B and C represent the growth of a $1 000 investment beginning in 1981, 1991 and 2001, and ending on 31 December 2010. Although it is trite to say that past market performance cannot guarantee future results, missing the top 20 trading months in the 30-year investment period could have cost you $17 648 in potential earnings on a $1 000 investment made in 1991.
Driven by fear and greed, too many investors pull their money out of the stock markets when share prices seem poised for a protracted fall in the hopes of reinvesting when prospects improve. The inherent problems in this approach are that (a) timing remains a gamble and (b) there’s a massive cost associated with trying. By adopting and sticking with a buy-and-hold investment strategy investors can take advantage of the power of compounding, or the potential of invested money to make more money. It’s for no small reason that Albert Einstein said that “compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”
Whilst our advice is, and always has been, to adopt a long-term investment strategy and to remain invested regardless of market movements and volatility, we also believe that reviewing your investment portfolio regularly is essential. Making sure that your portfolio is correctly balanced to achieve your financial goals is part of a sound financial planning process. Moving in and out of the markets makes a mockery of any attempt to regularly review your portfolio, and the result will make rebalancing your investments near impossible. Whilst Evita Peron might have considered time to be her worst enemy, when it comes to investing, time is without a doubt your greatest friend and most useful ally. Rather than succumbing to the knee-jerk reactions of fear-driven investing, long-term investors should recalibrate their thinking, disengage their emotions and accept that they’re in it for the long haul. After all, you’ve got to be in it to win it.
Stay warm and dry this weekend!
Categories: Financial Planning