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How to time the market, and other wishful thinking

It’s hard not to be rattled in the current market. As investors, it’s difficult to watch wild daily gyrations of sharemarkets or to ignore all the doomsday financial headlines plastered with news of plummeting global indices and images of “growling bears”.

However, before you think about giving up on your current investment plans and moving all your money under your mattress “while the storm passes”, it’s worth considering the likely consequences of trying to time the market.

Investors who try to pick the lows and highs of the market almost always hurt their portfolio performance over time. International research – including the likes of Vanguard, Morningstar and Fidelity Investments - have shown that investors who try to time the market generally end up with much lower returns than those who simply “buy and hold”.

Part of the reason for this is that the best and worst trading days tend to cluster in brief and difficult to predict periods of time. So although it is tempting to try to trade in and out of the market during periods of market volatility, doing so also increases the risk of missing some of the best days in the market. That can have a major impact on returns.

A recent study by JPMorgan showed that an investor who stayed fully invested in the S&P500 index from 1996 to 2015 would have earnt an annualised return of 8.2% - even including the impact of the GFC. However, if that investor missed out in being invested during the ten best market days during that period, their annualised returns would fall to just 4.5%. Missing the best 40 days – just over 1% of the total trading days – would have entirely eliminated all gains made over the period!

This highlights the real difficulties and risks of attempting to time the market. Even a simple decision like deferring an investment “until the market recovers” could just as easily mean missing out on those crucial days or weeks when the market surges – a narrow window of opportunity which most of us are unlikely to anticipate and which could have a material impact on overall investment returns. This assumes you are successful in timing your market exit in the first place – which is certainly not assured either.

Ultimately, the biggest problem with trying to time the market is that you actually have to be correct not just once but twice. First, you have to ensure you sell at the right time (i.e. at or near the market top) and then secondly, you have to get the timing right in terms of buying back in when the market bottoms. The likelihood of getting these moves right is very low. Even professional portfolio managers rarely get this right on a consistent and repeatable basis.

While obviously no strategy can guarantee a profit or protect against loss, history suggests that it is time in the markets, not timing the markets, which matters most when building wealth for the long term.

That’s part of the reason why we don’t try to time the market and/or pick winners at Six Park – and why we focus heavily on keeping costs low and offering portfolios which are tailored to match our clients’ investment horizons and risk appetites. It’s also why we encourage our clients to maintain a diversified, long-term outlook and to avoid emotion-driven, reactionary investment decisions.

Read more about our approach and offering here.

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