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It's all about time, not timing

In Jason Zweig’s book titled Your Money and Your Brain, the author refers to research done to determine people’s financial decisions based on playing a simple game.

Each player was given R200. They could “invest” R10 in a coin toss or they had the option to skip the coin toss to eliminate the chance of losing. If the coin landed on heads, the player was rewarded with R25, i.e. a reward of their initial R10 investment, along with R15 in returns. If the coin landed on tails, however, the investor would lose their entire R10 investment.

Mathematical probability states that you have a 50/50 chance of winning or losing, which means that technically, if an investor played along each round, they could have landed on heads roughly 50% of the time, meaning that they could have had a total of R250 in their pockets after 10 tosses. The chance of success, therefore, was greater than the chance of failing.

When it came to playing the game, it was found that the players only participated 58% of the time. They were hesitant to invest, especially when the previous toss landed on tails. The pain of losing R10 caused them to sit out the following toss 59% of the time. The lesson learnt from this experiment is that a fear of financial loss seems to hide in most of our brains.

We’ve been experiencing more light tremors in the market recently, which makes us aware of the fact that international markets cannot keep reaching record highs every day until the end of time. But are these only light tremors before the big earthquake hits?

Markets are still trading at record highs and I have to agree with other experts that the stock market presents a tremendous amount of risk for investors at the moment. The FTSE/JSE All Capital Index is already down by 1% for the past 12 months (5 August 2015 to 5?August 2016) and there are countless investors who, when considering these book losses and warnings (including my own), would like to sit out this round of investing in the stock market. But this can be a huge mistake.   

To quote from my article, How to keep emotions out of your investments (30 June edition): “So you did your homework, you know what can go wrong and you invested within your risk profile. What next? Buy a mountain bike, a set of golf clubs or even a good pair of running shoes and leave your investment alone over the short term.” No one has a crystal ball that can provide us with accurate predictions. The success of investing in shares isn’t determined by your investment timing, but rather by time itself.  

The best way to illustrate this is to look at the three great corrections over the last 20 years. If you were unlucky enough to have only three investment opportunities and you had invested at peak levels on all three occasions, you would have invested your funds in April 1998, May 2002 and June 2008. On each occasion, you would have lost 39%, 30% and 385% of your capital respectively over the following 12 months.

Of course this would have left any investor jittery and I have no doubt that most of them would have wanted to skip the next round like the players in the coin toss. But it is also a fact that these would have been only temporary paper losses, had you taken the time to be patient with your investment.

Those who waited patiently would have found that their investment dated June 1998 would have only underperformed compared to the money market up to the end of November 1999. Purchases made in May 2002 would have underperformed up to January 2005 and the most recent correction in 2008 would have underperformed up to the end of August 2012.

If you had an investment horizon of five years or more, your timing wouldn’t have made much of a difference, as you would have outperformed a conservative investment such as money market quite comfortably over a five-year period. 

The lesson we can all take from this is that when you have an investment horizon of more than five years, the risk of not investing in the stock market is greater than the risk of investing in it.

This article originally appeared in the 1 September edition of finweek. Buy and download the magazine here.

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