Before looking at why or how people try to time the markets, it is important to consider stock market volatility. This is the erratic up-and-down movement that is often seen in financial charts, and it is a measure of uncertainty. After all, markets carry a lot of uncertainty, including known unknowns and unknown unknowns.
While steep falls can be unnerving, it’s important to bear in mind that volatility is actually a sign of a healthy stock market. Short-term volatility is the price you must pay for the chance of higher long-term returns. Extremely low volatility is worrying – it often suggests that investors are being complacent.
Short-term market movements are often the result of changes in valuation and sentiment – how investors feel about the stock market. This is in contrast to long-term market movements, which are the result of changes to companies’ fundamental worth.
Investment guru Benjamin Graham once explained that in the short term the stock market is a voting machine that measures the popularity of companies, whereas in the long term it is a weighing machine that measures each company’s substance and value. At Tilney we believe that these short-term movements are impossible to forecast consistently without a crystal ball. On the other hand, long-term market movements are more predictable.
It’s natural to be concerned when markets fall, even temporarily. After all, nobody wants to lose money. This is why some people try to time the market.
Timing the markets involves trying to second-guess the ups and downs, with the hope that you will buy when prices are low and sell when they are high. Of course this can be lucrative if you get it right consistently, but this is very difficult to do and getting it wrong means locking in losses and missing out on gains.
A less extreme example of timing the markets is sitting on the sidelines during periods of volatility and waiting for things to improve. This could be by selling all of your investments or holding back from investing new money. And with political issues such as Brexit and the US/China trade war causing stock market volatility throughout 2019, many people have been doing this recently.
Not only is timing the market difficult to get right, it also poses the risk of missing the ‘good’ days when share prices increase significantly. Historically, many of the best days for the stock markets have occurred during periods of extreme volatility.
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. For instance, between May 2008 and February 2009 in the depths of the global financial crisis the MSCI World index dropped by -30.4%. By the end of 2009 it had bounced back +40.8%.
Inflation is another, often overlooked risk of keeping your money out of the stock market. Its power can be seen in the steady increase in the price of goods – from a first class stamp to a one-bedroom flat.
When your money is kept in cash, it won’t keep pace with inflation. Your account balance won’t decrease, but you’ll actually be losing money in ‘real’ terms (in other words, you’ll be losing spending power). Conversely, investing has the potential to outpace inflation and give you a ‘real’ return over the long term.
Instead of trying to time the market, at Tilney we believe that spending time in the market is more likely to give you good returns over the long term. We base our investment decisions on the long-term fundamentals rather than short-term market noise.
Of course this means experiencing the bad days as well as the good days, but markets and wider economies have a tendency to go up over time. This applies to everything from share prices to the price of goods. For instance, the MSCI World index has delivered average annual returns of +10.9% since it was launched in 1969. We believe that successful investing requires patience and taking a long-term view, and being comfortable riding out the short-term ups and downs for the chance of a much better return over longer periods of time.
You can see evidence of this trend by looking back at how the stock market has performed in the past. We calculated the minimum and maximum annualised returns that you could have received by investing in the global stock market for every single 1, 3, 5 or 10-year period since 1970*. The results are shown in this chart.
The first bar shows that the possible returns from 1-year periods (such as from 1970 to 1971) were extremely varied. Investing in any 1-year period could have given you a return between -30.27% and 56.24%. This demonstrates the volatility that can be seen in stock markets over the short term.
But over 10-year periods (such as from 1970 to 1980), annualised returns ranged from 0.21% to 23.69%. Not only were there no periods where the index fell, but the range of potential annual returns was also much narrower.
Although the past can’t be taken as a reliable indicator of the future, this does suggest that investing for longer periods of time decreases the chance of overall losses. On top of this, it suggests that short-term stock market volatility tends to cancel itself out over longer periods of time, giving more consistent long-term returns.
One of the reasons that long-term investing has the potential to deliver such great returns is the power of compounding. Einstein allegedly called compounding the eighth wonder of the world, but it essentially means the snowballing effect of your returns generating more returns over time.
It is mainly seen through the reinvestment of dividend payments into more shares – to subsequently receive more dividend payments and buy even more shares. However, you can also see its effect when companies reinvest their profits in advertising, more staff or better services and subsequently see their profits increase.
The power of this historical upwards trend can also be seen if you consider a fictional investor that has invested at the worst possible times over the last 30 years and still made a profit**. If they had invested £10,000 into the global stock market at the peaks before each of the following events:
Their original £50,000 investment would today be worth £219,778 – a profit of nearly £170,000! Of course past performance isn’t a reliable indicator of future performance, but it demonstrates how strongly markets have risen over the long term, even if you had invested at the worst possible times.
At the Tilney Group we have a consistent investment philosophy and process that feeds into all of our client portfolios, managed funds and the funds that we rate for Bestinvest clients. We believe in the power of investing for the long term, and the key aspects of our investment philosophy are:
At Tilney our investment professionals can help you to make the most of your money – either by managing your investments for you or giving you advice on all your investment decisions. To find out more about how we can help, or if you have any questions about your investments, please get in touch by calling us on 020 7189 2400.
Source for all data and graphs: Lipper for Investment Management, July 2019.
*Based on the performance of the MSCI World index from 1970 to 2019, across calendar years, with annualised returns.
**Based on the performance of the MSCI World index from 1987 to 2019, assuming each investment was made on the day of the nearest market peak.