"Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves." – Peter Lynch, Mutual Fund Manager
During periods of heightened financial market volatility, and increased levels of uncertainty, it can be tempting to try and time the market by selling assets and then buying back at a later stage. However, timing the market is virtually impossible, even for the most experienced investors. This is why it's often said that, time in the market is more important than timing the market.
As investors, we are often too emotional about the decisions we make. When markets dive, too many investors panic and sell; when stocks have had a good spell, too many investors go on a buying spree. Many investors try to time the market, however, having such a short-term horizon can harm performance and jeopardise your long-term financial objectives.
People tend to ‘panic sell’ based on their past experiences. There have been six major crashes in the past 30 years, so psychology plays its part.
- 1987 Black Monday
- 1997 Asian economic crash
- 1998 Russian economic crisis
- 2001 Tech stock crash
- 2008 global financial crisis
- 2020 COVID-19 selloff
It is never an easy ride on the way up in a bull market. Investors seem perpetually concerned, worried about the valuation levels, forever peering around the next corner and ever watching for the canaries in the coal mine that might signal the onset of the next market downturn. Prospect theory from behavioural finance suggests that investors are more likely to focus on gains rather than the perceived risk of loss when the outcome of an investment is uncertain. This ties into regret aversion where the fear of a loss outweighs the joy of winning – hence many investors panic sell when the going gets tough. This is a large reason why investors are always encouraged not to look at their investments every day.
The pace at which markets react to news means stock prices have already absorbed the impact of new developments and when markets turn, they turn quickly. Those trying to time their entry and exit may actually miss the market bounce. Timing the market is trying to predict the future and you could end up being out of the market when it unexpectedly surges upward, potentially missing some of the best performing days.
No one can consistently pick the best or worst days of the year, so this is why it can be so dangerous for investors to miss time in the market by trying to time the market. If you miss one or two big days, compounded over time, this can greatly impact your portfolio.
The graph below illustrates how a hypothetical $100,000 investment in the S&P 500 Index would have been affected by missing the market’s top performing days over the 20-year period from 1 January 2002 to 31 December 2021. For example, an individual who remained invested for the entire time-period would have accumulated $616,317, while an investor who missed just five of the top performing days during that period would have accumulated only $389,263.
Source: BlackRock, Bloomberg
Adding to the difficulty of trying to time the markets, most of the best days happen around the worst days. Over the last 20 years, 70% of the best 10 days happened within two weeks of the worst 10 days (Source: Factset). Incessantly going in, and out, of the market erodes returns and can also have tax implications and transaction costs.
It is true that a broken clock is right twice a day and hindsight is wonderful, but we are not soothsayers. If it was easy to time the market, lots of investors would be doing it and retiring early in the Bahamas, but this is not the case. We must remember that short-term volatility is the price you must pay for the chance of higher long-term returns and let the power of compounding take effect rather than potentially crystallising losses.
Diversification
Avoiding all risk is impossible but we must look at what we can control in the investing world – having a well-diversified portfolio that can weather the stormy financial markets is one of the few things we can do.
Each of the coloured boxes in the chart below represents a different asset class, don’t worry if you can’t clearly see which is which, it isn’t a very clear picture. The point is that there is no clear pattern that emerges over time, as to which is the best asset class to invest in, thus the only way to be sure of capturing the ‘free’ rate of return that capitalism provides is to invest in the most diversified way possible, which of course, is what we do.
In summary, holding a highly diversified portfolio and not responding in a knee jerk fashion to short-term market volatility is the best way to guarantee long-term returns in excess of inflation. BUT, in pursuit of these returns we must accept that, from time to time, markets will fall and losses can appear on paper, however, these losses are temporary, they only become permanent if you sell.
Having spent most of this piece arguing that timing the market is a very difficult game to play, it does stand to reason that when markets have fallen, opportunities to invest at better prices do arise. As I always say, markets could still go down from here, but one thing is certain, they are cheaper than they were 4 or 5 months ago, so now could be a good time for the long-term investor (all of our clients) to add to their holdings.
As always, if you have any concerns about your own financial arrangements and whether you are truly making the most of your money, please do not hesitate to call me.
With kind regards,
Yours sincerely
Graham Ponting CFP Chartered MCSI
Managing Partner
