The recent market rallies have left many novice investors in a tizzy. In hopes of timing the market right, their constant ‘wait to get in’ and ‘want to get out’ could be the cause of some sleepless nights. Their hopes may have been raised by associate investors who swear by their exceptional comprehension and mastery of market rallies, but is timing the market something that can truly be mastered?
Decades of research and analytical experience substantiate ‘the gamble’ that timing the market can be. Author and investor Gary D Lemon in his book Savvy Investing demonstrates the difficulty in predicting the market. He takes into account the annual returns of S&P 500 for a period of 20 years from 1994 to 2013.
S&P 500 ANNUAL RETURN 1994 – 2013
|Annual Return||Annual Return if you miss the five best days||Annual Return if you miss the ten best days||Annual Return if you miss the forty best days|
During these 5,000 trading days, less than 1% of it(i.e. 40days) could be considered as the best days for investing. If you missed these 40 best days your returns would have fallen from 9.2% to -1.9%. Similarly, there were 40 worst days as well that add to that equation; investing on those days would wipe out your 9% profit made on the best days and maybe some more.
“I make no attempt to forecast the market—my efforts are devoted to finding undervalued securities.”
The current market rally is even more difficult to define with a combination of monetary policies, stimulus packages, moratoriums, and other financial reliefs that could be driving it. These external factors further complicate the possibilities to time the market. The stock market consists of a group of successful organizations; the key here is to identify the best businesses out of these that are most likely to do well in the near future despite the unprecedented circumstance. Market corrections are an ideal time to benefit from the wealth-building power of stocks.
Active or Passive
For passive investors, in for the long-haul, the safest bet is to invest in a diverse set of funds (a combination of stocks and bonds) that mirror the market dynamics. This ensures your funds do well when markets rally. For active investors it is vital is to comprehend the fact that even the savviest of investor’s like Warren Buffett does not depend solely on timing the market for gains. Often investors miss grabbing great opportunities in the anticipation of corrections. Corrections are a common occurrence and a market decline of 10% can be considered a yearly phenomenon. Most major market declines or gains occur once within a decade and span for a few days. Determining those few days of volatility is like finding a needle in a haystack. Then there are uncertain situations like the current pandemic that has unrelenting effects on the economy driving the market down an unknown path. Considering this, short term investments should be made post ascertaining risk capacity and is best done with surplus funds.
Whether you are investing for short-term goals or long-term ones, there is an absolute need for building a reserve. These unpredictable times are a lesson for many investors who have put all their eggs in one basket (like the stock market) and now are on a back-foot running from pillar to post raising funds to manage their essential expenses. This is a situation that occurs when periodical financial planning takes a back seat. As investors, it is important to ensure you set aside an equivalent amount for expenses that could arise in the near future. Take into consideration a ballpark figure for your essential expenses for a year or two ahead. Park this amount in liquid investments that are not or least affected by market volatility, take for instance like traditional instruments like FDs. The last thing you want to do is cut your losses in a falling market to pay for your essentials. Having a reserve to fall back on can ensure you reduce any knee jerk reactions in stock investments especially during volatile markets.
To sum it up, don’t let greed or fear drive your rationale to buy or sell. Have an asset allocation that is aligned with your risk appetite, this will ensure you have the ability to stomach losses even during the most turbulent times. Revisit your financial plan periodically to ensure your portfolio is hedged against risks, your reserves are maintained and your financial goals are aligned.
“The stock market is designed to transfer money from the active to the patient.”