As Warren Buffett once famously said, “The only value of stock forecasters is to make fortune tellers look good.”
Most stocks can result in a massive profit, but what has led many of investors to try and time the market is the opportunity of taking a gamble and “Hitting it big”!
Understanding volatility is paramount! Before one looks at how or why individuals try and time the market. It is important to first consider stock market volatility. Volatility can be defined as the degree of variation of a trading price over time, or the erratic up-and-down movement of a stock based on many factors such as economic releases, company news, or unexpected earnings results.
SMART investors know that it is impossible to predict a stock’s outcome. However, it is only human nature to make the wrong decisions when it comes to your investments, especially during times of crisis.
It is also natural to be concerned when you see markets fall sharply and the value of your investments decreases. As per the previous Global Financial Crisis, once again the COVID-19 pandemic has shown how fast things can change in financial markets.
While steep falls in the market can be concerning, it’s important to bear in mind that investment or price volatility is usually associated with investment risk; and short-term volatility is the price you must pay for the chance of higher LONG-TERM returns. This is why we call it “long-term investing”.
What is Timing the Market, and does it work?
As you may have guessed already, Timing the market is where a person tries to predict the future. Although it sounds ideal to buy stock and sell it shortly after it has made a huge profit, it is often times more complicated and costly than that.
There are people who manage to get lucky, but it is only luck. One may consider the idea of winning consistently but where one may have luck with one stock trade, he/she may lose it all on the next.
The cost of Market Timing
One of the biggest costs of market timing is being out of the market when it unexpectedly surges upward, potentially missing some of the best-performing days, or points in the cycle.
This can occur when people try to adopt the ‘buy low, sell high’ approach where they try to consistently determine when a stock has hit its lowest or highest point.
A classic example:
An investor may assume the market will drop, switches out or sells off the equity allocation in his/her portfolio and places the money in more conservative investments, such as cash. While the money is out of stocks (equity), over the next year the stock market enjoys a high-performing period. The investor has, therefore, incorrectly timed the market and missed those top days or months.
The importance of Time in the Market
Instead of trying to time the market, we believe that spending time in the market vs timing the market is more likely to deliver good returns over the long term, whilst removing the anxiety of losing part or all of your life’s savings.
Of course this would mean taking the rainy days along with the sunny, but if history has proven anything, it is that markets and economies tend to have an upward trajectory over time. For instance, the MSCI World index has delivered average annual returns of +10.9% since it was launched in 1969.
At Smart Financial, we base our investment decisions on the long-term fundamentals rather than short-term market noise.
For some, it’s difficult to invest that much time in the market, but one should remember how it aligns with their financial goals. The investment may be needed for retirement purposes, marriage, purchasing a new home, or even saving for their child’s education. So, there are important factors that come into play.
By waiting for steady and achievable growth over time, SMART investors are able to achieve their long-term financial goals, as outlined in their financial plan.
The power of Compounding returns
As Harry Markowitz once justifiably noted that diversification “the only free lunch in finance,” this meant that investors get to have the benefit of reduced risk while diversifying into various asset classes.
Not only do investors get to enjoy this benefit over the long-term, but they also benefit from the potential to achieve great returns from the power of compounding. This essentially means that get to enjoy generating more returns over time via the “snowball” effect (Interest on interest).
For example, when a person invests in equities for 10 years, the positive effects of compounding coupled with investment growth reaps significant rewards.
An Investment journey of Three friends
The need to make changes to our investments may provide temporary emotional relief and a feeling that we are slightly more in control of the situation, but at a cost. In the longer term, the wrong decisions taken during market volatility and times of uncertainty can have a devastating effect on your investments as well as into retirement.
The last time the markets experienced a similar shock like the one earlier in 2020 was the global financial crisis of 2008/2009. Many investors would have taken the knee-jerk decision to switch to ‘safer’ investments or sell out of the market, irrespective of their investment goals.
To try and time the market as an investor, as John and Michelle did, is a guaranteed way to lock in any losses and, consequently, also to miss out on any potential recovery in markets. So what should investors do? Like Claire, doing nothing is often the best strategy.
Let’s see how the different Investment Strategies faired…
Let’s take three friends, all aged 30 years, as an example of what to do, and what not to do when it comes to investing. Claire, John, and Michelle, after receiving financial advice, all decided to invest €10,000 each into an aggressive fund on 1 January 2020. By 23 March, after a rocky time in the markets – the stock market had already crashed by more than 30% because of uncertainty around the pandemic and the worldwide lockdowns – John decided ‘enough is enough’, he wants his money to feel safer and switched out of the fund into a conservative fund.
Michelle, worried about the markets and panicking, decided to withdraw all of her money from the fund and keep it in the bank. Claire, however, listened to her financial advisor and decides to stay focused on her long-term goals. She keeps her money in the fund, knowing that her that her investment strategy should always align with her goals.
In April the market begins to recover, as markets usually do. At the end of June, Claire is better off than John and Michelle. Claire’s investment is now worth €9,100. This is still less than the initial investment, but she knows her money is in the most suitable fund for her personal circumstances, and that over time her money will grow and she will achieve her financial goals.
John, who switched to the conservative fund, is worse off than Claire and his money is now only worth €8,300. On top of that John’s investment – if he doesn’t switch back to the aggressive fund – will likely not grow as much as Claire’s, and over the long term, he will be worse off.
Michelle, who panicked and withdrew all her money into the bank only has €7,500 at the end of June. Michelle will have to reinvest back into the original fund if she wants her money to grow over the long term, but she will buy back at a time when the markets have recovered and she has less money to invest, which will most likely leave her in a worse position over the long term compared to his two friends Claire and John.
The lesson is, be like Claire , and not like John or Michelle…
Investing has more to do with waiting than doing – let your Financial Advisor guide you through your journey.
There’s never been a better time for Financial Advice
Here at Smart Financial, we can’t stress enough the importance of investors focusing to their goals, as well as the time frame for their financial plan, before starting the investment process.
For any one who is looking to weigh up the pros and cons of time in the market vs timing the market, its important to remember that, although market volatility can produce the feeling of financial uncertainty, TIME IN THE MARKET will offer a better outcome for your future!
How our Smart Financial Advisors can benefit you through the ups and downs:
- Discuss why it’s important to prevent unnecessary risks and costly mistakes by avoiding emotional decisions.
- Help you prepare a financial plan to address immediate challenges and to put a strategy in place for you to achieve your long-term financial goals.
- Our Advisors have a wealth of training, knowledge, and experience in the financial industry, who can assist you to make SMART DECISIONS about your money, to budget and save accordingly.
- A Financial Advisor will undertake research on a regular basis in order to ensure they are up to date on current events in the industry, and of the markets, so you don’t have to.
- Giving you assurance that your financial future is well looked after, and that we are one phone call away…