Trying to time the market could be hindering you from doing better today!

Posted In Investments | Personal Wealth
17 Aug 2017
trying to time the market

In this day and age, with information being available at our fingertips, we are exposed to many conflicting ideas regarding investing. This information overload causes most investors to feel nervous about getting into the markets. Instead, many investors find themselves siting on the sidelines attempting to time the market. This is a lost opportunity as the longer you wait on the side lines, the longer your money is not capitalising on any growth or compounding interest.

It can be a very daunting prospect as to when is the best time to get into the market and it’s a very common question for most potential investors. So, when is the best time to invest? should I invest now or wait?

There is a theory that has coined from a 1960’s Ph.D. dissertation by Eugene Fama (Nobel Prize in economics, 2013) called the efficient market hypothesis which concludes that at any given time an asset’s prices fully reflects all relevant information. Therefore, securities always trade at a fair value on stock exchanges and it is nearly impossible to predict when is the best time to enter or exit the market. It is evident that neither individual nor professional investors can outperform the market consistently over long periods of time. This has been backed by studies done on fund managers, active traders, and other institutional investors, who have failed to find persistent outperformance that was not caused by luck or being in the right part of the market at the right time.

Most investors, however, do just the opposite, something that financial planners have always been warning them to avoid, and thus lose their hard-earned money in the process. Warren Buffett the most successful investor in the world, once said, “the only value of stock forecasters is to make fortune-tellers look good. Even now I continue to believe that short-term market forecasts are poison and should be kept locked away from children and also from grown-ups who behave in the market like children.”

Common investor’s whom attempt to “beat the market” may find themselves falling short, either missing the ‘ideal’ moment and sitting on the sidelines over long durations playing the waiting game or never even getting into the market. Only select few are lucky enough to catch the wave.

Princeton Economist Burton Malkiel, whom is famous for writing the classic finance book ‘A Random Walk Down Wall Street’ also concurs with the theory by saying “I have never known anyone who could consistently time the market and in fact never known anyone who knows anyone, who was able to consistently time the market.”

“Time in the market, not timing the market” is the rallying cry for buy and hold investors.

The graph below is a mere representation of the effects an investor would have if the investor missed out on the best 25 days only, the worst 25 days only and the best and the worst 25 days (of 11,620 days) since 1970 as opposed to having invested throughout.

If the investor managed to miss all 25 best days, the returns would have dropped from a 6.7% per annum to a 3.4% per annum whereas the wizard that manages to miss the 25 worst days would have gained on average 11% per annum over the period.

Growth of $100

Growth of $100

(Source)

 

The graph above is more of a representation of what could happen and not a suggestion that it will be easy or even possible to miss all the 25 worst days and be invested during the 25 best days. A more interesting observation can be made from the data collected above which is represented in the graph below.

30 Day Standard Deviation

30-day standard deviation

(Source)

 

Based on the graph above, the worst 25 days and best 25 days tend to cluster. The green dots represent the 25 best days and the red dots represent the 25 worst days. Furthermore, they cluster during volatile markets. All 50 of these days occurred when volatility was above average (the black line). Therefore, missing the worst days and being in the market for the best days is nigh on impossible.

The most important thing is to understand the risks inherited in whatever you’re doing as trying to time the market during these very risky times could potentially leave investors with a bad taste in their mouths.

In the long run, disciple breeds success. As we have seen, markets move in cycles and over short periods, markets can be more volatile and result in a wide range of positive or negative returns. The key takeaway is the longer you stay invested, the greater the probability that your investment will generate a positive return. As shown in the graph below, investing in global stocks for periods of 12 years or more has resulted in no negative returns.

Chance of negative returns when invested in global equities for different durations

chance of negative returns

(Source)

 

Investment is not just about picking the best stocks or even asset classes nor is it about timing the market or concentrating funds in a specific market sector. Real results are achieved through compounding performance over long time frames; increasing returns while lowering risk throughout this period is best achieved with diversification across stocks, sectors, and asset classes – a short-term approach increases risk and can significantly impact your overall wealth plan.

Chance of negative returns when invested in global equities for different durations

(See our portfolio management page for more information)

 

As the above graph shows, over time the ups and downs of asset classes tend to even out and the gap between the highest and lowest returns closes. A higher return over time can be achieved for a lower level of risk by combining multiple asset classes.

So, you should never try to time the market. In fact, nobody has ever done this successfully and consistently over multiple business or stock market cycles. Catching the tops and bottoms is a myth. It is so till today and will remain so in the future. In fact, in doing so, more people have lost far more money than people who have made money.

The underlining statement that should be taken from the article is that “Time in the market, not timing the market” reduces the risk of investors losing their money as well as creating sustainable growth over the long term.

So, what is stopping you from starting today?

Sunil Ramesh

Written by  Sunil Ramesh

Sunil, or Sunny as he’s affectionately known, is the cash flow modelling and technical guru at Nexus Private Wealth Management. He holds a Bachelor of Engineering from the University of Queensland, a Diploma in Financial Planning and Advanced Diploma in Financial Planning. He is also currently completing his Graduate Diploma in Financial Planning.

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