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Time in the market beats timing the market

Posted by Stanley Chan on Feb 16, 2021 12:35:02 PM

Despite the incredible long-term returns delivered from investing in stock markets, they’re actually very volatile in the short-term. Looking at the S&P 500, for example, the proportion of days that it has gone up is 53% and the proportion of days that it has gone down is 47%. And as a result of this, no one has been able to accurately predict these short-term market movements consistently. 

Instead, what we do know with 100% certainty is that by trying to time the market means that on some days (simply by definition) you’ll have sold out of the market. A strategy of trying to time the market is therefore a strategy which guarantees that you’ll reduce your exposure to these incredible long-term market returns.

 

The hidden risks from selling your investments

At first glance this might not seem like much of a problem. If you were to buy and sell fairly evenly, then you might think that you’d be exposed to about half of the underlying long-term market returns, right? This doesn’t seem so bad. The problem with this, however, is that actually not all investing days are created equal... These long-term average market growth rates experienced across time are actually driven by a relatively few number of individual days, because each of these days has delivered a substantial one-off increase. As such, the majority of days perform significantly worse than these star days, and they drag the overall average return down. Trying to time the market simply means that you’re increasing the time that you’re out of the market, and it means that your strategy is exposing you to the risk of missing out on these star growth days.

Let’s look at the impact of this with the S&P 500 Index. If you’d have invested $1,000 in the S&P 500 in January 1950 and held it until July 2020 you’d have ended up with $184,651 at the end. But what would you have ended up with if you’d missed out on the top 5 performing days within this time period? The total value you’d have ended up with by July 2020 would have shrunk to $114,532. By missing out on just 5 days across 70 years you’d have wiped out about 40% of your total return. 

Widening it just slightly, if you’d have missed out on the top 10 performing days, you’d have ended up with only $82,530. You’d have lost more than half of your total return. And If you’d have missed the top 20 days, you’d have ended up with just $47,958. You don't have to miss out on that many of the star days at all to really feel the impact.

 

Investing the same amount regularly is the most successful market timing strategy

Warren Buffet famously said that the stock market is a device to transfer money from the impatient to the patient. By holding your investments for the duration of your investment, and as such not buying and selling throughout, it means that you can avoid the market timing risk and always be exposed to those few, important growth days. 

Moreover, if you’re at the stage of building up your savings and investments, then investing on a regular basis with the same amount each month creates the optimal outcome for you. There are two main reasons for this. Firstly, it’s a neat hack to automatically lower the purchase price of your investments (this is because when the price is lower, you automatically buy more units of your investment, and when the price is higher, you automatically buy fewer units. This is referred to as ‘Dollar Cost Averaging’). The second reason is much simpler - you can set up a monthly direct debit with a stock broker to invest in a selected ETF once a month, and then you’d never have to worry about it ever again…

Time in the market beats timing the market, and today there are lots of providers set up to help you do this in a completely hassle free way. 

 

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Topics: Investing principles, ETFs

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