Why timing the market is a bad idea

When it comes to investing, time can be your best ally, or your worst enemy. When time is on your side, you have the luxury of being able to ride out the volatile periods, and subsequently share in the good times that follow market corrections. These recoveries are often initially intense in nature, and contribute a big part of investment returns over the long run. 

However, if time is not on your side, it’s not that easy. What happens if you are only two years away from retirement and you haven’t saved enough to reach your retirement goals? Inevitably you are going to want to take more risk in order to try and make up for lost ground. 

But what happens if there is a massive market correction, like we had in 2008? This is where time is your biggest enemy. After the crash of 2008, it took the South African equity market about two years to get back to the levels that it was before the crash.

The equity market lost roughly 40% of its value over a period of only nine months (May 2008 to February 2009). So just imagine the disastrous consequences if you were a new investor in January 2008 who didn’t know any better.   

But this is where it gets interesting. We did some research on the JSE Alsi Top40 Total Return Index (TRI), going back all the way to June 2002. What we found was quite fascinating, and it illustrates how time can be your biggest friend when it comes to investing. 

Many potential investors perceive investing in the stock market as being just like gambling, but the numbers show that this is very far from the truth. 

Going back to June 2002, if an investor entered the market at any point in time and stayed invested for a period of three years and longer, the worst (cumulative*) return over any three-year period was 0.76%. 

Keep in mind that this includes the crash of 2008. The best cumulative return over any three-year period was 207%. The picture looks even better over a five-year period, with the worst cumulative return being 33% and the best return over any five-year period being 370%. It is important to stress that these returns were cumulative in nature, and not annualised. 

But, beware the volatility! We also looked at the numbers over a period of one month and one year, and here it’s a different story. Over one month, the lowest return was -13% with the highest return 14%. Over a year the variance was even bigger, with the lowest being -38% and the highest 73%.  

The variance in returns is recorded in the table below. What we are trying to demonstrate is that over a period of three years and longer, an investor would not have lost money in nominal terms if they were invested in the South African equity market at any point between 2002 and 2016, including the market correction in 2008. 

The other important point is that investors should remain invested during times of market volatility. Investors who try to time the market will get it wrong more often than they will get it right. Quite often, the consequence of this is that they end up buying high and selling low. 

As already mentioned, market recoveries often happen very quickly after a correction, and if an investor decides to get out when the going gets tough, it becomes very difficult to get back in at the right time. 

For example, an investor that was invested for a 10-year period, from January 2006 to December 2015, would have made a cumulative return of 270% on their investment, but if they missed only the top five months during the 120-month period, the total return would have been 220%. To put this in perspective, a fifth of the total return came from only five months. Also, three of the five top-performing months were in the first six months of the recovery after the 2008crash. 

There is only one way to avoid being your biggest enemy when investing, and that is to ensure you have  goal, and a plan that guides you on how to get there. Minimising investment risk should not be done by trying to time the market, but through an appropraite asset allocation strategy, reducing your exposure to volatile asser classes depending on your time horizon. This is where proper financial advice is inavaluable.

Rupert Giessing is a director at Vista Wealth Management, a representative under supervision of Accredinet Financial Solutions.

This is article originally appeared in the 14 July edition of finweek. Buy and download the magazine here.