It can be tempting to try timing your investments to get the best possible returns. Especially during market falls, when it can be scary to watch your hard-earned savings fall in value.
At the peak of the COVID-19 crisis, UK equities fell more than 30%. That feels like a lot, and it may seem like a good idea to try and sell your investments before things get worse. If this is how you feel, you’re not alone. Retail investors sold a record £10bn of fund assets in March, according to figures from the Investment Association.
But successfully timing the market is near impossible and you run the risk of losing more money in the long run. In fact, over the long term, the average investor hasn’t managed to time the ups and downs correctly, leaving them with less money than if they had just left it invested.
For example, a Research Affiliates study has shown that between January 1991 and June 2013, mutual fund value investors underperformed the funds they invested in by 13.1% per year, while the average growth fund investor underperformed the average growth fund by 31.6% per year. The biggest reason for this underperformance, according to the authors of the study, are ill-timed buy and sell decisions (though other factors also play a part).
Not convinced? Here are a few reasons you should stay away from trying to time the market.
Investing is a long-term game so ups and downs shouldn’t matter and returns get smoothed out over time. Even in the deepest of crises, history shows that given time, there is light at the end of the tunnel.
For example, a Morningstar study shows that it took the FTSE All Share index two years to recover following the 2008 financial crisis, while many UK equity fund managers turned things around even more quickly than that. It felt (a lot) longer at the time, but with the benefit of hindsight, the argument for sticking to your guns becomes much clearer.
The opportunity cost
Remember how we talked about the magic of compound interest? Well, this magic only works if you stay invested, and the longer you are invested, the more exponential growth you might see in your savings. But if you frequently take money out of the market, the power of compounding is diluted.
You would also lose out on any income from your investments. Recent research from Janus Henderson Investment Trusts shows UK investors lost out on a total £38bn of income over the last 12 months by keeping savings in cash instead of investments.
Irrational decision making
The professional investment community is very familiar with the theory of behavioural finance, a study of behavioural biases that can subconsciously impact decision making.
Many books have been written on the topic and we will dig into this topic in more detail in future posts, but essentially the research shows that humans are not always rational, particularly not in a crisis. Decision making in a time of crisis tends to be more emotionally driven. You may be an exception, but for most of us, it’s hard not to panic when everyone else is (including the market commentators).
Contrarian investing is hard, but if you can keep a cool head, then it might be worth considering one of the things Warren Buffett famously said: “Be fearful when others are greedy. Be greedy when others are fearful.”
Trading costs add up
Last, but not least, buying and selling assets frequently can be very expensive as trading fees tend to rack up. If you are investing in individual stocks or ETFs which commonly have trading charges, then every trade you make has an impact on overall costs and, ultimately, your potential return. So it is important to be sure of your decision before you trade, as it can cost you in more ways than one.
So as you can see, trying to time the market can be a very costly exercise and you may end up in a worse place than you started, costing you precious returns in the long run. As stressful as it may be to watch your savings plunge in value in a crisis, most of the time you are better off just looking the other way and getting on with your day. Often in life we are our own worst enemy, and this is certainly a high-risk zone for that. Market corrections are perfectly normal, in fact, markets wouldn’t function properly without them.
A popular way of minimizing the risk of buying high and selling low and making any big lump sum decisions in times of crisis (or euphoria...), is regular investing. With a good asset allocation plan as a foundation, regular investing saves you the hassle, practical and emotional, of having to figure out what to do and when. Life is hard enough without trying to outsmart trillion-dollar stock markets.
Date of publication: 21st October 2020
The information in this post is not financial advice, it is provided solely to help you make your own investment decisions. If you are unsure about whether an investment is appropriate for you, please seek professional financial advice. You can find more information here.
When you invest you should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future return.