In his book Investing for Growth, Terry Smith discusses the challenges of market timing and the impact it can have on investment returns. Missing just a few of the best days in the market can significantly reduce returns. Here’s an excerpt from the book:
It is not hard to see why we are almost all bad at market timing. It is hard enough to have the strength of conviction to convince yourself that markets are too high and sell when the background is looking rosy and everyone else is bullish.
But it requires an extraordinarily flexible psyche to be able to complete the required volte-face at the bottom and buy the stock, market or fund after your predictions have come true, its prospects look bleak and the price has fallen.
Another way of looking at this problem is to examine how few days you need to miss being in the market to seriously damage your investment returns.
If you take the decade from 31 December 1994 to 2004, the S&P 500 Index produced a compound total return of 12.07% each year. That’s what you would have got – before costs – if you were fully invested in the index. Put another way, $10,000 invested at the outset of the ten-year period would have become $31,260 by 2004.
But what if you have tried some market-timing moves and as a result missed a few days in the market, which happened to be some of its best days in that decade? What if you missed just the best ten days?
That’s not much, is it – one day per year on average. Maybe, but your return would be cut to 6.89% a year and you would be left with $19,476. If you missed the best 30 days, your returns would be negative.
You may argue that you might also have missed some of the worst days, but all the evidence is that there are more good days than bad days. Do you really think you are good enough to spot those days and make sure you are fully invested and ready for them? I know I’m not.
Which brings me to my punchline: there are only two types of investors – those who know they can’t make money from market timing, and those who don’t know they can’t.
This is why I seek to follow the advice from a great investor, which is that you should buy low and sell high, but if you are buying stocks in high-quality companies, it doesn’t matter if you forget the second bit. But that’s an article for another day.
You can find a copy of the book here:
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