Should I stay or should I go?
Between the pandemic, inflation, and geopolitical tensions, market uncertainty reigns supreme right now. You might have heard some disturbing words, like shares “plunging”, prices “soaring”, and investment “volatility”. Many people, therefore, are asking themselves: should I take money out of the market and get back in when skies are clearer?
The challenge with predictions from commentators on TV
No one knows what financial markets will do. Even the most experienced analyst or economist can only predict whether it will go up or down within a certain period based on the conditions they see at the time. But is there an opinion to be trusted? How do you weight the validity of someone’s prediction? Here is a thought experiment. What if we tracked the success rate of predictions made by commentators, much like we track the batting average of professional baseball players? We could then display the track record of the commentator on the screen as they are making a prediction about the future. This would help people determine how much weight to attribute to a commentator’s opinion. Without this level of accountability, people can make predictions freely, without much downside to being wrong. Nasim Taleb argues that people without a vested interest, or what he refers to as “skin in the game”, should be paid no heed. If you were to act on these predictions – to make changes to your portfolio based on what you think will happen, this is known as trying to “time the market” or “market timing”. In the recorded history of investing, very few, if any, investors have been able to time the market with any type of consistency. When you choose to exit the market, in effect you’re making two-timing calls – predicting the market high (when you get out) and the market low (when you get back in). It’s our belief that market timing is a fool’s errand.
Counting the cost
When you get it wrong, you miss out on the market’s best-performing days. There is a lot of research to show just how costly that is. In a 2018 report, Morningstar did an analysis to see how much an investor could have earned in returns by staying invested in the U.S. stock market from 1997 until 2017, which included 5,217 trading days. That number, it turned out, was 7.2%. But if that investor had missed the 10 best days in the market during that time, they would have earned only 3.5%. Miss 20 days, and their return shrank to 1.2%. If they had parked their money during the 30 best days, they’d have ended up with a -0.9% return. So, by sitting out only a month of the market’s best days in a 20-year period, an investor would have more than erased all their potential gains during that time. In the same report, Morningstar looked at annual returns from 1970 until 2017, and analyzed how missing the best month of each year would have affected the year’s returns. It revealed that taking away the best 30 days of a given year could slash annual gains by more than half.
A February 2021 analysis from Brompton Funds, a Canadian investment fund firm, found that someone who stayed invested in the S&P 500 through the course of 2020 – including the bear market caused by the pandemic – would have been rewarded with an 18.4% return for the year. Missing the market’s best day would have cost them more than 10 percentage points, and not investing on the two best days would have turned their 2020 into an annual loss of -1%. Here’s the kicker: the best-return days in 2020 happened in March, the same month when market fear was at its highest and many investors had already run for the hills.
How to stay invested
Let’s be clear: it’s a mistake to exit the market, even when it’s rough going. The question should not be whether you are invested but how you are invested, which depends on an individual’s stage of life and risk tolerance.
For example, let’s say you’re a young investor in your early to mid-twenties. You’ve got a job that pays a decent income, and you’re just hitting your stride in your professional and personal life. You’ve got decades before you retire, and are working on goals like travelling, getting married, getting your kids through school, owning a home, building a nest egg, and maybe even leaving a legacy.
For you, wealth accumulation is top priority, and time is on your side. Historically, the stock market has been up far more times than it has been down. You also still have a lot of earning potential and ability to recover from any dips in the market. You can afford to be bold and invest a bigger portion of your investable portfolio in equities.
However, if you’re retired, you may be more focused on preserving what you have as you don’t have the parachute of time or a working salary. That doesn’t mean you exit the market at the first sign of trouble. Instead, you may benefit from being more defensive in your portfolio. Of course, the specific strategy will depend on the individual’s circumstances.
It is in turbulent times that we want to make changes to our portfolios. The fact is that this is precisely the time to stay the course. Staying investing is not always easy. Making changes can seem very attractive. But remember that missing out on just a few days can devastate a portfolio. It may sound cliché, but the following statement holds true.
Remember, time in the market beats timing the market, every time.