The Cost of Trying to Time the Market

All / 01.12.2016

The Cost of Trying to Time the Market

Risk of missing the best days in the market 1996–2016

DESCRIPTION

The bottom chart shows the daily gains and losses in the Australian stock market since 1996. Within that “noise” are the 100 top returning days to be invested.

The top chart shows the impact of being invested throughout the period compared with missing a varying number of the best investing days.

EXTENSION

Investors who attempt to time the market run the risk of missing periods of exceptional returns, leading to significant adverse effects on the value of a portfolio. This top graph illustrates the risk of attempting to time the stock market over the past 20 years by showing the returns investors would have achieved if they had missed some of the best days in the market. The bottom graph illustrates the daily returns for all trading days.

Investors who stayed in the market for all trading days achieved a compound annual return of 8.3%. However, that same investment would have returned 5.5% had it missed only the 10 best days of stock returns. Further, missing the 100 best days would have produced a loss of 6.6%. Although the market has exhibited tremendous volatility on a daily basis, over the long term, stock investors who stayed the course have been rewarded accordingly.

The appeal of market timing is obvious – improving portfolio returns by avoiding periods of poor performance. However, timing the market consistently is extremely difficult. And unsuccessful market timing, the more likely result, can lead to a significant opportunity loss.

Returns and principal invested in stocks are not guaranteed. Holding a portfolio of securities for the long-term does not ensure a profitable outcome and investing in securities always involves risk of loss.

ABOUT THE DATA

Stocks in this example are represented by the S&P/ASX 200 index, which is an unmanaged group of securities and considered to be representative of the Australian stock market in general. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes or transaction costs.

PRINCIPLES

It is very tempting to believe that you can enhance your investment returns by jumping in and out of the market at the right times.

This belief is emboldened by looking at previous market booms and busts and re-assessing them as predictable in advance. (This is known as hindsight bias.)

In reality, the ability to consistently and accurately predict the best times to buy into or sell out of the market is a very valuable skill, but not one many (if any) people possess.

The benefits of successfully “timing the market” can be immense, but must be considered alongside the potential downside, being out of the market at the wrong time.

As the top chart shows, there were more than 5,000 investing days over those 20 years and missing just the top 1% of them  would turn a 9% gain into an 0.5% loss, missing the top 2% would result in a substantial loss.

 

 

© 2016 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. Any general advice or ‘class service’ have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement (Australian products) or Investment Statement (New Zealand products) before making any decision to invest. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 (“ASXO”).