To time the market or not to time the market, that is the question which plagues investment professionals the world over. There is something intrinsically (at first) appealing to the idea of timing the market (and eschewing the buy and hold strategy) – consider the following scenario.
The market has dropped 2.2% and there is some fear-mongering on the financial news channels. You reckon that if the market turns down another 2% tomorrow then you’ll avoid the bloodbath, switch your equity investments into cash and wait out the storm. Things go somewhat your way, the market does take a knock and you are self-satisfied at your prescience. It’s been a week, the market has dropped further and today the market rallies 3%. This is what you have been waiting for! You place your trades, high five your colleagues and sleep well.
The next day the market drops another 3% in what is known as a “dead cat bounce” and the rout continues. You switch out again, all the while incurring costly brokerage fees and say you’ll wait much longer this time before jumping back in.
The above scenario can play out in a number of different ways, but the one truth is that in the very short-term, equity markets are nigh unpredictable.
To attach some hard evidence to the above example, consider that the performance (read: gains) of the S&P 500 since December 1959 to 29 February 2016 can be condensed into approximately 51 of the best days of trading. That’s slightly longer than 2 and a half months of investing. Furthermore, out of the 14 148 trading days between mid-December 1959 and end February 2016, roughly 53% have posted gains and roughly 47% have posted losses. The point here is that being out of the market for even a few of those critical days could have hurt your long-term performance considerably. The chart below shows this:
The S&P 500 Without its 5 and 10 Best Trading Days
In terms that are more comprehendible, the standard S&P 500 has had a compound annual growth rate of 6.41% annually since 1959. Excluding the best 5 days pushes this down to 6.05% and excluding the best 10 days pushes it down to 5.74%. Over just more than 56 years, this is a return of 3181% for the S&P 500, 2619% without the best 5 days and 2198% without the 10 best. This means that those 10 days in isolation, when considered over the whole holding period, multiplied an investor’s money by about 10.
While one could keep coming up with new, fun ways to present this information, the moral at the end of this story is that the long-term opportunity costs of trying to time the market could be massive. The point? Buy and hold for the long-term.
And, just for fun, if you had managed to foresee the 10 worst days for the S&P500 since 1959 (which there is no way you could!) you would have returned 4261% (6.95% CAGR)!