It is important to understand the consequences of trying to time your investments in the stock market and the relatively low probability that you will get both timing decisions involved correct; namely selling out of the market while it’s still declining and then re-entering before the recovery has come to an end.
Locking down investments in lockdown
In statistical terms, because it’s a ‘binary outcome’ (you either sell at the right time or you don’t), the risk that the ‘average’ investor sells out of a falling market at the right time is 50%. Assuming this decision was correctly timed, then the next step is timing when to re-enter the market. Again, this is a binary outcome, so it too has a 50% probability of success.
The problem is that the odds of timing both moves correctly is 50% x 50% or just 25%. So, the odds of an investor getting one side of the equation wrong and potentially suffering a loss is actually 75% – not a very inviting prospect for most investors.
Add to this the fact that making a successful decision as to market timing is much more likely if you have access to a broad range of real-time market research and analysis tools (and the time required to employ them and come to a well-reasoned conclusion) and it’s clear that the odds are stacked against the ‘average’ investor.
2020 in 20:20
If we take the example of the MSCI World Index in 2020, the difficulty of timing markets in real time becomes clearer – it’s only in retrospect that market timing seems like a good idea.
The news that the coronavirus had reached mainland Europe in February sent global equities into a tailspin. They began a precipitous fall on 20 February that continued until 23 March before news of a massive $2trn US stimulus package – the biggest in history – triggered a rebound in markets.
By then, the MSCI World Index had fallen more than 33% with March seeing the two biggest one-day sell-offs in US equities since the 1987 ‘Black Monday’ crash. This means that investors had an effective window of just over four weeks in which to sell out of equities before the market changed direction once more with the move becoming steadily less worthwhile as the clock ticked down.
By late March, the news of an anxiously awaited US stimulus deal triggered an historic ascent for equity markets around the world. On 24 March, the Dow Jones Industrial Average Index of US blue-chip stocks soared more than 11% in its biggest one-day jump in almost 90 years (since the Great Depression in 1933). Meanwhile, the S&P 500 Index climbed some 9.4% on the day while the tech-heavy Nasdaq Composite Index gained just north of 8%. The following two days were almost as impressive in terms of market gains around the world.
Indeed, between the market opening on 24 March and closing on 26 March 2020, the MSCI World Index gained just over 17%, this means that any investor who sold out during the down ‘window’ but failed to be reinvested for these three days would have missed almost exactly half of the total recovery.
Importantly, it took the MSCI a full six months to recover to the level it had reached on 20 February, but half that recovery came between 9.30am on Tuesday 24 March (when US markets opened) and 4.00pm on Thursday 26 March (when US markets closed) – some 54.5 hours.
Put another way, any investor who missed this three-day ‘up window’ would have needed to have divested from markets by around 12 March in order to be in the same position as if they had stayed invested throughout (reducing that ‘effective window’ for selling out from just over four weeks to barely three).
The best of times…
As 2020 amply demonstrated, it’s extremely difficult, even for practiced professional investors to accurately predict when a market is about to tank or, conversely, when it will start to recover vigorously. The best indication of a potential crash is a rise in market volatility (as measured by the VIX index) but that’s only half the story. Such peaks in volatility, which can come and go with surprising speed, are also the best indication that a positive market move is waiting in the wings.
As we saw in March, this means that the best days in market history inevitably follow hard on the heels of the worst. By extension, this means that those investors who try to time their entry into and out of markets are really only increasing the long-term risks to which their portfolios are subject – risks that may not pay off.
The chart below highlights just how expensive missing out on the ‘good times’ can be. It shows how much someone who notionally invested £10,000 in the MSCI World Index at the start of 1997 would have lost if they missed the best days in market upside between then and the end of June 2020.
While someone who stayed the course and remained invested throughout the period would have accrued a total investment of £63,645; missing out on just five of the best days (over the course of more than 22 years) would have cost them very nearly £20,000 in lost compound growth. Had they missed the best 25 days of the period they’d be almost £50,000 adrift by the end of June 2020.
Indeed, according to the latest figures from the Office of National Statistics, our notional investor would have needed their £10,000 to have grown to around £18,300 in order to have kept pace with UK inflation over the period meaning that losing those 25 days not only erased any potential gains but also delivered significant ‘real’ losses, despite more than 22 years of investment!
If selling out of the market at the wrong time is like shooting yourself in the foot, then failing to get back in again is much like shooting the other foot.
With increased market volatility ahead thanks to the social and geopolitical pressures exerted by an ongoing global pandemic, this is no time for anxious investors to try and time the market; the risks are simply too great compared to the potential rewards on offer.
This is where professional advice becomes invaluable.
Speaking to an AAM Advisory wealth manager will help you to identify the most suitable way for you to make the most of your cash. Together you’ll be able to define your aims as well as formulate a personalised plan.
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