Investors who follow financial pundits know that pundits are generally wrong more often than right when trying to forecast the stock market’s direction. So are investors who base their buy and sell decisions on the changing political or policy winds. But what if financial pundits and investors were right more often than not? As the market continues its historic ascent to record highs, what if they predict a steep 2020-like correction in the next couple of months? Do you pull your money out of the market hoping to avoid the worst of it? Or do you stay invested and ride it out?
That is the core of the never-ending debate over whether investors who attempt to time the market to maximize returns can do better than those who choose to remain in the market. Based on the massive inflows and outflows reported for mutual funds in and around market peaks and market corrections in late 2017 and early 2018, it appears many investors believe they can time the market. But, when you examine the market’s performance through decades of bull and bear markets, those who remain invested invariably come out ahead. Consider the following data on bull and bear markets from 1926 through mid-2018:
• The average duration of bull markets was 9.1 years.
• The average cumulative total return of bull markets was 476%.
• The average duration of bear markets was 1.4 years.
• The average cumulative total return of bear markets was -41%.
The key takeaway here is that every bear market has been followed by a bull market, which on average are six and a half times longer in duration. Also, bear market declines have always been erased in the next bull market, and the gains of the previous bull markets were extended significantly. In other words, over time, bear markets have been temporary interruptions of a more enduring bull market. While the market’s past performance is not an indication of future performance, the historical record is extremely compelling.
Missing The Best Days Of The Market Hurts Investment Performance
The challenge for investors who attempt to outperform the market by selling high and buying low is they need to be right twice.
Study after study seems to “confirm” that market timing doesn’t work for most investors. The data they point to the most to support their findings centers on the variance in returns achieved if you miss out on the best days in the stock market. Investors are warned not to sell during periods of extreme volatility, because if they miss some of the market’s best days, their returns will invariably suffer. The data presented in the studies appear to bear that out.
For example, Fidelity shows the impact on your returns if you had invested $10,000 in the S&P 500 and missed the five, 10, 30 and 50 best days out of over 10,000 trading days:
• If you stayed invested all days, your gain would have been $697,421.
• If you missed the 10 best days, your gain would have been $313, 377 with missed growth of $384,044.
• If you missed the 50 best days, your gain would have been $48,434 with missed growth of $648,987.
In other words, if investors who move in and out of the market miss out on the best return days, their overall returns will suffer. That seems compelling enough.
What makes market timing even more difficult for most investors is that many of the best return days occur very close to some of the worst days. So, if you abandoned the market during a steep decline, like the one in early 2020, you probably missed out on the best return days that year.
For example, there were two days in March 2020 with over 9% returns in the S&P 500. Both were ranked among the 10 best return days in history. The first over 9% day occurred March 13, the day after the second-worst return day in 20 years, leading many investors to capitulate. The next over 9% day occurred the day after the March 23 market bottom when all seemed lost.
By July, the market had rallied 40% from its March bottom. However, for investors who missed the five best days during that rally, their portfolio would be down 30%.
Few investors have the ability to predict which days they should be in or out of the market, yet many still try, often to disastrous results. A commonsense investment principle says that, for the best long-term performance, investors should buy low and sell high. In the short term, that is much easier said than done. But, when you invest in high-quality companies at fair prices over the long term, it’s a much easier decision to make.