[Estimated time to read: 3 minutes]
When volatility spikes, investors naturally pause and review their approach.
You can sort of picture it: they spot a huge move in the market, and they reach for the phone to call their broker to take advantage. Just before their fingers hit the phone keypad, they stop, think and gently put the phone down.
It's a classic head vs heart issue: the head is saying 'markets are cheaper, I should buy more', while the heart is saying 'yes, but I'm afraid'.
The temptation is often to wait a little longer: 'maybe they'll sell off a bit more, THEN I'll put some more money in', or similar.
The problem, of course, is that the market is made up of millions of other investors thinking through the same issues, with much the same underlying tension of fear and greed. And many of us think 'I'm happy to miss the first few per cent move – then I'll jump in'. But, once markets make those first moves, it can be even harder to step up as we think we have missed the opportunity.
Indecision leads to paralysis, and the moment is gone.
We're sure you are as familiar with this as we are. What might surprise is just how costly it is to get the timing wrong – and how hard it is to get the timing right.
It turns out that the days of greatest volatility are of huge importance in helping drive long term returns. While any sensible investors want to capture the best-performing and miss the worst-performing days, data shows that these are really hard to predict.
But what if you miss days like last Friday, when markets rallied hard?
Well, history gives a sense for the impact: the long-term return on the S&P500, the main US Equity Index, is 9.22% a year over 20 years. Those 20 years make up a little over 5,000 trading days.
Investors who tried to time their entry and exit to the market, but who missed the best 5 days, found their return reduced to 7% per annum; if they missed the 20 best days, their returns fell to just over 3%. And missing the 40 best days out of that 5,000 meant that investors actually lost money over the 20-year holding period.
In other words, missing (on average) two days a year of returns meant that investors missed out completely on the much-anticipated benefits of being invested.
If you could have perfect foresight and miss the 40 worst days in the market over 20 years, your annualised return more than doubles – which means that, over 20 years, your cumulative return is 9x the already impressive market return.
Playing games with the numbers, with the benefit of hindsight, is fun. But the lesson is a crucial one – it's when things are most volatile that the temptation is greatest to market-time: to try to buy at the bottom, sell at the top or, as in the example above, to stay out of the market for a little longer than you had originally planned 'to see how things settle down'.
You need to know that staying out of the market means that you will certainly not make the money on offer when those markets rally – that's obvious.
What's less obvious, but equally true, is that staying out of the market for any significant period makes it highly likely that your investments will ultimately lose you money. Sobering stuff.
We all know you need to be in it to win it – so if you want the market to work for you, you need to be invested. Through rough and smooth, thick and thin.
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