7IM believes that time in the market, rather than timing the market, is your friend. But what evidence is there that remaining invested could be a better strategy.
Anyone who has read Justin Urquhart Stewart’s articles will probably be familiar with his tenet of ‘it’s time in the market, not timing the market that is important’. We believe that concept is key for investors to understand; it’s those who remain fully invested over the long term – i.e. a minimum of five years, but preferably nearer eight to ten – who should reap the rewards of that commitment to ignore market movements in the short term (and which can be quite volatile). The investors who aim to buy low and sell high very rarely have perfect timing and will usually miss the peaks and troughs significantly.
I make this statement knowing how tough it is to time markets, even for someone whose day job it is to watch them. We often have a view about which way a market may trend, but we will rarely know when the trend starts, how far it will move markets and how quickly. Meanwhile the trading on futures exchanges, as an example, often takes place outside of office hours, and can have an influence on the underlying index when it next opens for trading and can’t be watched all the time by anyone. It is not possible to stay on top of everything, all the time.
When you’re an individual investor, there are even more reasons why timing the market is difficult. For most of us, practicality is up there – life gets in the way. We can't watch the market every minute of every day and so can easily miss that optimal time to buy or sell. As an individual, you also don’t have access to the information and systems that professional investors do and might not be able to accurately track the market or trade that investment as easily. Emotions also play a role. Losing out on an investment can be more than mildly annoying – it can actually change your future behaviour. If you've lost out in market movements once, there’s a natural tendency is to be wary of ending up in the same situation.
An example here is when investors waiting to be absolutely confident about a market rally before reinvesting. Waiting for certainty can be costly though, as investors buy back into their investments too late and miss the upside that they were keen to access. This is highlighted by this graph:
Source: Financial Express
Here, we give an example of a would-be investor who invested in the 7IM Balanced Fund (as per the green line). In October 2008 markets fell sharply. Here, the red line takes up the performance if they panicked, sold down into cash and then didn’t re-enter the market until March 2010 – perhaps when their view of the world was more optimistic, so they bought back into the 7IM Balanced Fund. By trying to time the market, they have cost themselves money. Had they stayed invested (just tracking the green line) their investment would have returned 68.50%, while the investor seeking to time the market (the red line) saw returns of 51.17%. On a £50,000 portfolio, while past performance is no indication of future returns, that’s a potential difference of £8,665. While missing out on gaining nearly £10,000 isn’t as emotionally painful as losing it, the financial impact is the same.
And while it’s easy to sit there say that no one would wait that long to buy back in, it’s worth remembering how dark a period 2009 was.
There are other ways of highlighting how time in the market is your friend. Here we dug into the detail of the FTSE 100’s annual returns over the last 20 years, measuring how well you could have done, just by missing the bad days – exactly the mentality investors have when they sell to cash. If you’d managed to miss the 20 worst days, you could have tripled your return.
Source: 7IM, Bloomberg
That seems attractive to most people! However, it is worth looking at the opportunity cost too. The chart below shows the portfolio impact of missing the best days in the markets. Miss the best 20 days (over a 20 year period!) and your portfolio loses money!
Source: 7IM, Bloomberg
Now bear in mind that most of the best days occurred within a week or so of the worst days. Is anyone that good at market timing, professional or otherwise?! Imagine if you had sold and managed to miss one worst day, but then failed to buy back in and so you miss the next best day too. The events could cancel each other out, or perhaps, have even worse consequences. By trying to time the market, you could be more likely to completely miss the boat. On top of this, you have to also calculate the costs of trading all these investments. 7IM doesn’t levy dealing charges, but a lot of firms do and you could up having to deduct quite a lot from the returns you have salvaged.
Last, but definitely not least, we also have to highlight that buying and selling on a regular basis means that you could be disinvested in a stock when it comes to the dividend pay-out date. We’ve exaggerated our timeline to 67 years here to lay the effects on thick and make our message clear: if you reinvest any dividends, they have a powerful influence on your overall returns. Excluding compounding, investing £100 over this timeframe would have (historically) delivered returns of £8,0011. Including the compounding, the return could increase to £147,384.
So what are you going to do?
1 Source: Bloomberg
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Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London EC2N 3AS. Registered in England and Wales number OC378740. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guide to the future. The investments may not be suitable for everyone and if you have any doubts you should contact your investment advisor.