A “buy low, sell high” approach is frequently related to timing the market. An investor might decide to sell shares of their equity investments, for instance, to protect a gain or avoid a loss if they thought the stock market was due for a correction. The distinction between investing and speculating can be made by comparing timing the market and time in the market. Timing and speculation both involve taking advantage of price fluctuations. However, the quality of an asset and the power of compounding only work in your favor over time in the market.
The Market Timing Conundrum
A study on the S&P returns over two decades is highlighted in chart A. While the overall CAGR stood at 7.68% an investor who would have missed the 10 best days of the fund performance may have gain a mere 4.01% annualised returns. These returns would barely beat inflation let alone earn a profit for the investor. Similarly, missing 30 or 40 of the best performance days during this period could have resulted in negative returns for an investor.
Markets move in cycles and tend to often fluctuate. There are some indicators that may serve as a good reflection of a given market phase. For instance, elections for a new government, or the start of a war and its aftereffects. This does not necessarily imply that one can accurately and reliably forecast when to enter and exit a market.
Why is it difficult to time the market?
An investor’s sentiments and behaviourial biases is one critical factor that makes timing the market challenging. For instance, when stock prices fall, it may be instinctive to press the sell button before you lose your invested principal. Unfortunately, a study has proven that many of the biggest gains for stocks occur in a bear market or during recession. According to statistics, 10 of the most profitable trading days over the past three decades occurred during a recession while another 5 days occurred during a bear market. For longer-term investors, missing the best days due to panic selling or staying away from volatile markets can significantly reduce returns.
How can ‘time in the market’ help gains?
- As illustrated above, it is in the handful of good days that a fund outperformance is witnessed. There’s a chance you’ll miss out on the good days or buy on the bad ones if you try to time the market. When compared to the fund’s CAGR, this might result in your investment underperforming.
In spite of the fact that your investments may be susceptible to market volatility too, “Time in the Market” ensures you stay invested throughout market cycles. Your losses and gains are averaged out over the long run offering risk-adjusted gains.
- When you try to time the market, you frequently become overly invested in the market’s short-term ups and downs. As a result, you might have knee-jerk reactions, adopt a herd mentality, or develop behavioral biases that lead you to make irrational decisions.
By staying invested for longer time frames you are less likely to be perturbed by short term market volatility. The likelyhood of noise in the market causing any knee-jerk reactions reduces drastically too. Long-term investing can ensure your investments are thoroughly thought and aligned with your set goals.
- Even for an experienced investor, there is very little chance of successfully entering a market with short-term investments during a market downturn. Particularly conservative investors ought to steer clear of such risky investment endeavors.
When held onto for a longer period of time, quality stocks typically outperform any kind of aggressive market timing strategy. The irrationalities of the markets typically become less extreme over time.
Instead of selling into volatile markets and attempting to steer clear of the worst-performing days, it is better to stay fully invested in equity markets over the course of an entire market cycle. We advise long-term investors to rebalance their portfolios on a regular basis to maintain a diversified allocation that is in line with their objectives. Through reduced volatility, diversification may be able to deliver more consitent returns while lowering downside risk.