Investing – timing the markets 17 November 2012
At this time of market uncertainty many of our clients are asking whether they should be investing now or waiting till later. Essentially what clients are asking us to do is attempt to time the markets.
The problem is that few people, if any, can predict the top and bottom of the market with any degree of accuracy or consistency.
Timing the markets is dangerous
Morningstar, an American fund rating service, analysed the return on 219 funds for the period 1989 to 1994. Over this period the average return on these funds was 12.5% a year. However, when they analysed the actual return of the investors in these funds they found that their return was -2.2%.
The investors in these funds did considerably worse than if they had adopted a completely passive approach and merely bought the funds and held onto them for the same period.
Similar research shows that between November 1986 and November 1996, the FTSE/JSE All Share Index grew on average by 20.73% a year. However, the following data is quite interesting.
- If you missed out the 10 best performing days, your return declined to 13.79%
- If you missed out the 20 best performing days, your return declined to 9.10%
- If you missed out the 30 best performing days, your return declined to 5.02%
- If you missed out the 40 best performing days, your return declined to 1.47%
The details above highlight the danger of trying to time the market. Why is that?
Simply this: most investors tend to buy and sell at the wrong time.
The interaction between the human psyche and investment markets is interesting. Normally if something is cheaper, for example, shirts at our favourite store – we buy more of them. Not so with investment markets. When shares are cheap we tend to sell them!
The best time to invest in equities is often when the outlook for equities is at its bleakest. Normally investors will sell once share prices have fallen and the outlook is uncertain. Investors will buy once share prices have already risen.
Strategies to negate your emotions
When investment markets are uncertain, clients may be advised to phase money into the market over a number of months or years rather than investing a lump sum. Should the market fall further, the investor will be able to purchase more units; when the market recovers, the investor will be in a better-off position. However, if the market rises during the phase-in period, the investor will purchase fewer units than had they simply invested the lump sum, and they would in fact be worse off.
- Monthly debit orders
The advantage of maintaining your regular monthly debit order investment during times of uncertainty, and possible market weakness, is that you will be receiving more of the particular security for the monthly amount invested as the price of the security is now less. Once the price of the security increases, the value of your investment portfolio will be worth more.
- Portfolio rebalancing
Rebalancing helps to keep your investments in line with your investment strategy. The idea behind rebalancing is to reduce risks created by the build up of an excessive sum of money in any given asset class. It is important to note that portfolio rebalancing is not an attempt to time the market, but rather the continuous implementation of an investor’s long term strategy.
In short, it is essential to separate the negative long-term effects of fear and greed from your investment affairs and harness the awesome power of compound interest. Consult your financial planner in order to determine the appropriate investment strategy for your portfolio.
Morné Bezuidenhout CFP® is a financial planner at Netto Financial Services.