Financial Mortgage Advice

Time in the market

It is time in the market, not timing the market

What does “time in the market, not timing the market” mean?

The phrase “time in the market” usually refers to the benefits of investing for the long term.  Long term investing means buying investments with a long term view – with the plan to hold onto them and gain the benefits of compound growth over time

 

 

When people talk about “time in the market”, they’re often discussing the benefits of taking a long-term approach to investing. This means buying investments and giving them time to grow, taking a patient approach and understanding that it’s compounding over time which will deliver results and grow your portfolio.

“Timing the market” refers to the practice of trying to actively buy assets at their lowest price, and sell them at their highest. The difficulty here is in accurately predicting and timing these events, meaning you could be leaving a lot of money on the table if you sell at the wrong time.

So, the phrase “time in the market, not timing the market” is all about how it’s better to buy assets to grow and hold, rather than trying to actively buy and sell dips or peaks. This is a strategy that many investors attempt to use, where they try to time their entry into specific markets to capture the best prices. The trouble is that it’s very difficult to make investment decisions based on short term data, and as the last 2 years have shown us, it can be very difficult to predict how markets will react to pieces of news – and even more difficult to predict the news itself!

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What is market volatility?

Before looking at why or how people try to time the markets, it is important to consider stock market volatility. This is a mathematical measure of the erratic up-and-down movements we see in share prices. Volatility is often what unnerves first-time investors who have grown used to the certainty of money in the bank.

Consider a company like Unilever. The consumer goods giant has dozens of brands from Dove to Domestos, which it makes and sells in countries across the globe from Canada to Cameroon. Its share price reflects how each of those products are selling in each of those markets, as well as investors’ best guesses for how those products will perform in the future. These factors constantly change, so its share price will naturally move up and down to reflect those changes – volatility.

Can diversification help with volatility?

One way around this volatility is to diversify – in other words, buy lots of shares. Buying any one company can be a rollercoaster ride but buying lots of them smooths out some of the ups and downs. For example, if your Netflix shares are suffering as economies open up and people leave their homes more, your Starbucks shares might be doing better as people start to socialise and drink their coffees again.

The simplest way to diversify is to buy a fund – an active fund might have 50 stocks in its portfolio, while passive ‘tracker funds’ can buy hundreds of stocks covering a whole stock market. But even if you own every company in a market, the fact remains that markets themselves are volatile, at times very volatile.

What causes market volatility?

Apart from how companies themselves are doing, markets also reflect confidence in the wider economy. Economic growth, interest rates and inflation can all have an impact even at the best of times, and that’s before we get on to less predictable events like a banking crisis or a pandemic. Introducing confidence also brings in another factor, human emotion, which is both hard to predict and prone to fluctuation.

So how do I avoid volatility?

Staying in cash
One way to avoid volatility is not to invest at all. Savings accounts guarantee you your money back, plus interest. However, removing stock market risk carries its own risk: inflation. Its power can be seen in the steady increase in the price of most goods – from a first-class stamp to a four-bedroom house.

Low interest rates mean that if your money is kept in cash, it might not keep pace with inflation. Your account balance will still go up, but you’ll be losing money in ‘real’ terms (in other words, losing spending power). Conversely, companies can often beat inflation simply by raising their prices, so investing has the potential to outpace inflation and give you a ‘real’ return over the long term.
Timing the market
Some investors try to beat volatility in another way, by trying to time the market. This involves trying to second-guess the ups and downs, with the hope that they will buy when prices are low and sell when they are high. Nobody wants to lose money, so why not simply invest when times are good and sell out when times are bad?

The answer is that it’s extremely difficult. If everybody knew bad news was around the corner, they would already have sold their shares and markets would already have fallen.

Those who do sell out ahead of a crisis make headlines precisely because they’re so rare – think of the US housing market crash in 2008. The small number of investors who predicted it were portrayed by film stars in The Big Short, while the lives of the millions who lost money were quietly ignored by Hollywood.
Sitting on the side lines during volatile markets
A less extreme example of timing the markets is sitting on the side lines during periods of volatility and waiting for things to improve. And with issues such as Brexit, the US/China trade war and the pandemic causing higher market volatility in recent years, many people have been doing just that.

However, those who did this missed out on some of the best ever years to be invested, like 2016 when global markets rose +29.0% or 2019 when they were up +23.4% [1]. When bad news dominates the headlines, the good news that drives profits and share prices higher is easy to miss.

Missing the best days in the market

Keeping your money in cash can seem wise when markets drop sharply, but it can lead to a different error. Timing the market carries the risk of missing the ‘good’ days when share prices increase significantly. And historically, many of the best periods for stock markets have occurred during periods of extreme volatility.

For instance, between May 2008 and February 2009 in the depths of the global financial crisis the MSCI World index of leading global companies dropped by -30.4%. By the end of 2009 it had bounced back +40.8%. Anybody who pulls money out in the early stages of a volatile period could miss these good days, as well as potentially locking in some losses.

The importance of time in the market

Instead of trying to time the market, we believe that spending time in the market is more likely to give you good returns over the long term. Of course this means experiencing the bad days as well as the good, but history has shown that there tends to be more of the good days and over time this difference tends to mount up significantly.

For instance, the MSCI World index of leading global companies has delivered average annual returns of +11.1% since it was launched in 1969. It has been a bumpy ride at times, but we believe that successful investing requires being patient and taking a long-term view, riding out the short-term ups and downs for the chance of a much better return over longer periods of time.

Experiences from history

 

There is a reason people are feeling nervous based on their past experiences. There have been five major crashes in the past 30 years.

The power of compounding

One of the reasons that long-term investing has the potential to deliver such great returns is the power of compounding – the snowballing effect of your returns generating more returns over time. Einstein allegedly called compounding the eighth wonder of the world, and some simple examples show what he meant

Compounding is mostly achieved through dividend payments, which can be reinvested into more and more shares over time. However, you can also see its effect when companies invest their profits to grow their business – this generally results in greater profits going forward, and a higher share price. A prime example is Amazon. The company has never paid a dividend, instead reinvesting its profits into its IT systems and distribution network, turning itself into a trillion-dollar business in less than 25 years.

Why now could be the right time to invest

While steep falls in your investments can be unnerving, it’s important to bear in mind that short-term volatility is the price you must pay for the chance of higher long-term returns. Rather than try and second-guess market movements, a better strategy is to ride them out and invest for the long term. Your choice of portfolio should reflect your individual circumstances. However for those who are going to invest, the answer to the question “When is the best time?” is almost always “Now!”

Timing the market is almost impossible

During periods of stock market volatility, it’s human nature to be concerned. We’ve previously looked at ‘loss aversion’ and how the human psyche behaves during market falls.

To try and avoid stock market dips, some investors try and ‘time’ the market. The aim is to buy when prices are at their lowest and to sell when prices reach their peak.

Naturally, this can be lucrative if you get it right. The key issue here is the ‘if’. Not even the most celebrated investors or star fund managers can time the markets and getting it wrong means locking in losses and missing out on gains.

Take a recent example. On March 12th, the Dow Jones experienced its biggest one-day fall since 1987. Had you withdrawn from the market then, you’d have missed out on the single biggest weekly Dow Jones rise since 1974, which happened in the week before Easter.

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