Published on: 8th May 2020
You may have heard the saying ‘it’s time in the market, not timing the market’ when investing. But whilst we know we shouldn’t try to time the market, it can be difficult to understand what impact a mistake would have on your finances.
Timing the market sounds like a great strategy, after all, buying low and selling high can help you maximise returns. The trouble is, it’s impossible to do so consistently. Even fund managers with dedicated teams and resources get it wrong at times. There are so many external factors, as well as internal ones, that will influence how well a company performs, it’s not possible to predict the peaks and troughs constantly.
Take the current market volatility, for example. It was widely speculated last year that 2020 would see low but stable growth in the UK economy. The coronavirus pandemic and associated measures now mean GDP could contract and an economic downturn could follow for months or even longer. If you’d been weighing up timing the market, a global pandemic is unlikely to have even been considered last year.
There’s also a risk that you’d miss out on the most profitable days due to mistiming dips.
The cost of missing out on a market recovery
Research from Architas has highlighted the impact missing out on a market recovery can have on your finances. Looking at the performance of the S&P 500, the index that measures the stock performance of 500 large companies listed on exchanges in the US, between 1992 and 1019 found:
- If you’d remained fully invested over the entire period, you’d have benefitted from returns of 1,134%
- But if you missed just the best five days, this would fall to 719%
- Miss the best 30 days in the 27 years and returns would be 164%
Whilst you’d still end up with gains, you’d have missed significant opportunities to grow your wealth.
You’d have to be unlucky to miss the 30 best days of the market, but the research does highlight how a few mistakes can have an impact, particularly when you factor in the effects of compounding.
As the market experiences volatility at the moment, you may be considering altering investment plans you made in the past. However, at times like this, it’s important to remember that time in the market is what matters.
Time in the market
When you begin investing, you should do so with a long-term goal. This should be at least five years away, giving you a long period to invest.
This allows you to hopefully ride out the dips in the market and benefit from the peaks too. Whilst a short-term snapshot of investments is likely to show plenty of movement and steep rises and falls, over the long term, this is smoothed out. When you look at the performance of your portfolio over ten or twenty years’, you should see a steady rise overall.
For most investors, time in the market is far more powerful than trying to time the market.
Of course, we can’t predict what will happen in the markets. This is what makes timing the markets so difficult. But when you look at historical trends, markets have always recovered and gone on to deliver returns following a decline or period of volatility. This was the case following the 2008 financial crisis, the dot.com bubbles and the other ‘market crashes’ that came before.
Why do we try to time the market?
There are many reasons why you may be tempted to time the market, but most of these tend to be emotional reasons. Whether it’s because you’re worried about losing money or believe you’ve found ‘winning’ stocks, this is an area where financial bias can have a significant impact.
Financial bias refers to making decisions based on emotions rather than logic and facts. It happens to us all at some point, and there are numerous ways financial bias can have an impact. This includes ‘groupthink’, the process of making decisions based on what others are doing without context for their actions, or confirmation bias, where you actively seek information that supports your already preconceived ideas.
Some types of financial bias can give you confidence that you’re able to make investment decisions about when to enter and exit the market. Perhaps previous investment decisions have resulted in gains because you exited at the ‘right’ time. But that doesn’t mean it’s something that can be done consistently.
So, how do you fight financial bias and keep your investments on track? This is one area where financial planning can help. First off, it gives you another perspective to look at financial goals and the steps you’re taking, as well as the experience of someone working in the industry. Second, it can provide you with financial confidence in your plan, reducing the feeling of needing to adjust investments as markets change, as your portfolio will have been stress-tested.
If you’d like to discuss your financial plan and how investments can deliver long-term gains, please get in touch.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.