In recent years we’ve become quite accustomed to hearing that share markets have, once again, reached all-time highs.
In 2020 alone, the MSCI All Country World Index – a barometer for the global share market – reached a fresh high 34 times. Hearing such news will typically generate two separate trains of thought by investors. On one level, it’s music to our ears. The market is up, our investments are in positive territory and the outlook for the future is generally optimistic.
On the other hand, it’s not uncommon to feel slightly apprehensive about the prospect of a market pullback, which may cause us to second guess our investment plans. For those that are fully invested, it’s “maybe I should be selling my shares now before it’s too late?” And for those sitting on cash, ready to invest, it’s “maybe I should just wait for the next market-dip before I buy in?”.
These nagging questions can eat away at us as investors and be a cause of stress and anxiety. But to what benefit?
When investing it’s important to recognise that the likelihood of being able to predict the very top of the share market is extremely low. There are just far too many uncontrollable market forces, and it is near impossible to predict how they will all play out – and in what order.
Whilst most hedge fund managers claim to have a superior ability in predicting market peaks and troughs, there is little evidence to suggest that this is possible on a consistent basis.
Nobel Prize winner, William Sharpe explored the concept in one of his earlier works titled “Likely Gains from Market Timing”, where he demonstrated statistically that in order to benefit from a market timing strategy you would have to guess right approximately 74% of the time1. Inferring that the odds of trying to time the market are stacked against you from the outset.
There is a common misconception that market timers only need to be right over half the time to be better off. However, given the market is upward trending over the long-term, it makes logical sense that for those days that we remain out of the market, or not invested, we are more likely to be hurt by “up” days than benefit from “down” days.
In fact, not being invested for just a handful of the markets’ best performing periods can have a significantly adverse impact on our portfolio’s overall performance. As the great fund manager, Peter Lynch once said, “More money has been lost trying to anticipate and protect from corrections than actually in them.”
The chart below further validates this notion and displays the impact of missing the 10 best days on the Australian share market since 2004.2
Daily returns of the ASX/S&P 200 Accumulation index (Source: Datastream) for the calculations, from 31 Oct 2003 to 04 Feb 2021.
Acknowledging the risks associated with market timing, investors might still feel uncomfortable with buying into a market that is at all-time highs. Particularly those who have encountered a major share market crash at some point during their investing lives.
A recent study by US wealth manager Ben Carlson, well renowned for his blog “A Wealth Of Common Sense”, hypothesised about an unfortunate investor who had only ever invested at the very top of the market (i.e. the day before subsequent market crashes), and the impact it would have on their investment performance over time3.
The table below identifies the points in time that this hypothetical investor would have bought into the market and the resulting performance that followed.
Keeping in mind that these were eight of the biggest share market crashes we’ve seen over the last hundred years, the subsequent returns over the next 20 to 30 years, in particular, are still quite reasonable.
The share market will always be exposed to short-term risks and volatility. Without it, there would be no available returns. However, if there’s one key take away from the analysis above, it’s so long as you have a long enough time horizon and can remain patient and disciplined with your investment plan, you can still achieve positive financial outcomes no matter how bad your timing.
As the saying goes, “It’s not timing the market, but rather time in the market that counts.”
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1 Sharpe, William F. (1975). Likely Gains from Market Timing https://www.tandfonline.com/doi/abs/10.2469/faj.v31.n2.60