Market Timing – Always Tricky

The case for staying invested

When markets are falling, it can be tempting to pull your money out of equities and take shelter in the comfort of cash or fixed income. Conversely, when markets are rising, it might seem wise to invest even more into what looks like a good thing.

But entering or exiting the market at just the right time – known as timing the market — can produce worse results than investing in a diversified multi-asset portfolio and holding onto it for the long haul. Because investors can often let their emotions rule their decisions, they tend to sell in a panic at the bottom of market cycles and rush to buy in a burst of enthusiasm when markets peak.

As much as any investor would like to avoid market downturns, trying to time the market generally adds risk and potentially costs to your portfolio. Trying to avoid being invested on the bad days and catching only the good days requires making two correct decisions:

  1. Getting out at the right time
  2. Knowing when to get back in

They’re both difficult calls to make with potentially real consequences to your portfolio.

Since no two market cycles are the same, it isn’t easy to anticipate market movements. All sorts of factors – politics, monetary policy, economic activities (such as corporate mergers and consumer spending), investor sentiment, international events — can move the markets. Often, reversals are quick and unpredictable and the market has picked up steam again by the time nervous investors feel confident that everything has settled and it’s an appropriate time to re-enter.

Take for example the spectacular market volatility surrounding Britain’s 2016 referendum on its European Union membership – known as Brexit. The day after British voters chose to “leave” the economic bloc, markets around the world reacted strongly: The S&P/TSX Composite Index lost -3.1% in the following two days of trading.

Other global markets also were jolted: the Russell 1000® Index lost -3.6% the day after the vote, and another -1.9% on the following Monday.

Many investors may have been tempted to pull their money out of the market until the situation settled down.

But if they had done so, they could have missed out on significant gains. Within a week after the Brexit vote, the S&P/TSX Composite Index had recovered the lost ground, then went on to advance 8.2% by the end of the year.

Market timers waiting for the right spot to buy can risk being out of the market during sudden market changes. As the chart below shows, an investor who missed the past decade’s 10 best market return days would have given up nearly half the portfolio return they could have earned if they had been invested for the entire 10-year period.

Source: Russell Investments, Confluence
Based on daily returns of S&P/TSX Composite Index for 10-year period ending June 30, 2017. For illustrative purposes only.

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

If we extend the number of ‘missed days’ to 40, the difference is striking:

  • An investor who missed the 40 best days over the last 10 years was left just 30% of their original portfolio value.
  • Conversely, an investor who missed the 40 worst days enjoyed a portfolio value worth over seven times more than the value of a portfolio that was ‘invested all days.’

The Bottom Line – Stay Invested

There are two facts that work against market timing.

One: The general trend in equity markets globally has been positive. Equity investing
over the last five, 10 or 20 years has not been a zero-sum game. An investor who “stayed the course” over this time is likely to have seen growth in their portfolio. You can choose to possibly benefit from that general trend or second-guess it along the way and potentially miss its benefits.

Two: Returns are lumpy: they have not moved in a linear manner. It’s certainly true that short-term volatility can be nerve-wracking. But rather than reacting to volatility and trying to time short-term market gyrations, investors should base their investment strategy on their investment goals, time horizon, financial circumstances and risk tolerance, not on what markets are doing at a given moment.

In partnership with your financial advisor, a well-thought out investment plan may prove more successful in achieving long-term outcomes. For example, investing in a multi-asset portfolio offers the potential to protect your portfolio on the downside, while still aiming to capture returns when markets rise.