eBusiness Weekly
You have heard it all before. Investing is actually easy — buy low and sell high. Individual investors who tried this themselves will have anecdotes of success using this approach, but figures show that emotional decisions about when is the best time to buy or sell have more often resulted in losses.
It is difficult to time the market at the best of times. The past 12 months, especially, have shown how unpredictable markets can be. Global interest rates are at record highs, inflation remains problematic in multiple countries, and the “R” word (recession) regularly makes headlines. Yet global markets have recovered well from the turmoil of 2022, and there is even talk of a recovery from that bear market.
The turmoil in markets over the past two years resulted in some investors doing what they often do in times of uncertainty: they withdraw from volatile markets into more defensive assets like money market funds or other assets in the hope of avoiding further fall-out in the markets.
However, data shows that not reacting to adverse market conditions is usually the best approach. In short: do nothing.
You can’t time the market
One of the oldest catchphrases you’ll hear about investing is that you can’t time the market. The lesson here is that while you might want to get out of a declining market before your portfolio loses more value, there’s no way to know when exactly to buy back in again. Time in the market is always a better approach than timing the market.
All too often, investors exit their equity positions in favour of less volatile assets but then stay out of the markets, hoping to find the best point to buy back in.
And when this happens, their fear keeps them rooted in low-return assets that don’t grow fast enough to beat inflation, meaning they’re constantly losing buying power.
This reaction is only natural because humans are programmed to base our decisions on recent events.
Known as the “recency bias”, this reaction makes sense psychologically because who wants to take on unnecessary risks? If your recent experience has been that markets are falling, then you usually expect more of the same.
Until, of course, when markets turn positive.
And when do you know that markets have turned? Usually too late.
Time in the market
Because we can’t predict the future, it’s only with hindsight that we can say with certainty when markets have turned from bear into bull territory.
Take, for instance, this graph that shows the impact on the average returns on the S&P 500 between 1993 and 2022.
If you had invested US$10 000 in 1993, missing only the 10 best days (out of the more than 7 000 trading days in this 29-year period), then your portfolio would have performed 54 percent less as opposed to staying invested the whole time.
Double the number of best trading days missed, and the opportunity cost rises to 73 percent, while you’ll be 83 percent worse off if you’d missed the 30 best trading days.
Bulls. Bears. Who cares?
What is most interesting about the S&P 500 returns is that most gains were not, in fact, as a result of bull market conditions.
According to the data, 52 percent of the best 50 trading days over this period occurred in a bear market.
The rest of the best trading days happen in the first two months of a bull market (26 percent), with the remainder of a bull market accounting for 22 percent of the best trading days.
Waiting for better days — which one would expect to find in bull market conditions — is clearly not a winning strategy. Investing needs time and, most importantly, patience.
As well as the recognition that up and down cycles are, but part of how markets work. What’s impossible to know, however, is when bear markets end and bull markets begin.
This question of when markets are going to turn is one that investors and fund managers are currently grappling with. With interest rate hikes slowing and possibly reversing in the next 12 months, some may feel that the conditions are looking slightly more positive in future.
Which they might well be. However, this question is less important if you’ve stuck to your investment strategy over the past two years and continued to invest irrespective of the state of equity markets.
As shown by the historical data, this is the most prudent approach to building long-term wealth. The added bonus is that you won’t be stressing over when to return to the market in a bid to catch the market at its very bottom. — Moneyweb
