In uncertain times, it is always worth remembering the old adage – that time in the market matters more than timing the market.
Recent market volatility has inevitably made some investors nervous. Last week, the S&P 500 fell by more than 4%, not a major fall historically but a pretty big decline compared to what most investors have grown used to in recent years.
There are other reasons for investors to worry as well. High market valuations, rising interest rates, the prospect of a no-deal Brexit and escalating trade tensions fuelled by Donald Trump all raise the likelihood of greater market volatility.
When markets do become more volatile, with investor sentiment turning negative and resulting in short-term falls in value, it can be tempting to try and time the markets.
Timing the markets involves attempting to sell before the equity markets hit the bottom, and then buy again before they start to rise.
It sounds good in theory. In practice, it doesn’t usually work out that way. Instead, you could find yourself selling low and buying high.
Repeat that process enough times and you will soon run out of money to invest. At the very least, the value of your investment portfolio will take a big hit.
One of the biggest problems with attempting to time the market is that you can easily miss out on a few of the best days of returns. Do this, and your overall long-term returns will be significantly worse.
According to a study from Fidelity International a couple of years ago, an investor who invested £1,000 in the FTSE All Share index 30 years ago but missed the best 10 days in the market since then would have achieved an annualised return of 7.09% and ended up with a total investment of £7,811.55.
That compares with an annualised return of 9.38% and investments worth £14,733.64 if they had stayed in the market the whole time – an opportunity loss of £6,922.09.
If the investor had missed the best 20 days, their annualised return would be 5.55%, which would have resulted in an even worse shortfall of £9,676.56.
This research reminds us that volatility is the price you pay for long-term outperformance from equities, relative to other investment asset classes. The potential for long-term returns comes from risk in the form of market volatility.
There are significant risks associated with trying to time the markets. This is because it is so difficult to predict the best time to get out and then get back in to equity markets, during periods of market volatility.
These risks are magnified by the impact of the very best and worst days of market performance tending to be grouped together during periods of increased market volatility.
A more sensible approach to investing is to keep your money exposed to the markets throughout the entire market cycle, during both the ups and the downs.
This works because it forces you to ignore your emotions. It is human nature to hang onto losing investments for too long and sell winning positions too soon. Or you buy at the top of the market when sentiment is good and then panic and sell at the bottom as markets fall. As Ben Graham, the father of value investing, once remarked, 'the investor's chief problem - and even his worst enemy - is likely to be himself.'
According to research by Charles Schwab, between 1926 and 2011, a 20-year holding period in the S&P 500 has never produced a negative return, emphasising the benefits of holding your portfolio for longer periods of time.
In volatile times, you should remember these two important factors. Firstly, don't forget the power of reinvesting dividends. Whilst markets may be currently down from their peaks, if you have reinvested the dividends earned, you could have still significantly enhanced your returns.
Secondly, diversification can help, and one way to do this is through funds. Good fund managers are usually still able to make money, even in volatile times and they can do the research, analysis and stock selection for you.
Part of our role as Financial Planners is behavioural coaching. When markets are especially volatile, we are there to guide our clients and keep them focused on their long-term investing objectives, helping them keep their subconscious emotions out of the process.
Because we recognise and can demonstrate the value of time in the market, and the futility of market timing in most circumstances, we believe we can help secure the best long-term results for our clients.
If you have been tempted to try a spot of market timing during the current bout of market volatility, why not give us a call and see if we can keep you on the right track.