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Trying to time the market is a fool’s errand

Sep 20, 2023

Roné Swanepoel, Business Development Manager at Morningstar South Africa, provides compelling evidence that trying to time the market invariably has disastrous results.

Trying to time the market is a fool’s errandLet’s start with a thought experiment. If you look back on your investment journey to date, and the various hot tips you received – whether that was the media reporting on the latest market craze, or something as simple as a friend’s hot tip at a Saturday braai ‒ how many times did you act and buy into these hot tips? How many times did it pay off? Are you possibly still invested in one of these stocks, sectors or funds? With the benefit of hindsight, are you happy you invested when you did?

Although these hot tips work out well for some, they are often handed out when the particular stock, fund or sector has already reached its peak in popularity. It not often that investors receive a tip when the price is still low, enabling them to buy in at a reasonable price to realise a decent profit.

We make some of our worst investment decisions by paying too much attention to opinions about markets where many of the variables are either unimportant or unknowable.

As markets turn more volatile and create uncertainty – as we have seen in the last year – opinions become louder, the pressure in the market mounts, and the headlines start jumping out at us begging us to try and time the market.

Headlines like “Markets and the economy to face a meltdown in 2023”, “The best stocks to profit from the AI trade”, “Market guru says his ‘once in a decade’ trade is upon us,” or “Reasons why you should move all your money away from South Africa”. We must remember there are two sides to any coin.

When very persistent narratives are so visible, it becomes difficult for investors to ignore these narratives. We become gripped with the things we don’t know and it becomes increasingly difficult to pick a good mix of funds for your investment portfolio – and avoid making big changes to it.

But you should ignore these narratives. As Morgan Housel once wrote, “99% of good investing is doing nothing…”

The power of doing nothing

Over the long term the stock market rises in value. Corporations like making profits. Money must go somewhere and people like the returns they get in the stock market. Simple.

The one factor that remains constant is that to derive these positive returns, you have to be invested. Unfortunately, that involves staying invested through periods when markets go up and down. Why? Because no one can accurately and consistently time the market.

Although we know the stock market trends up over time, the graph is never linear and constantly punctuated by turbulence, rallies and dips as can be seen in the chart below showing the S&P 500 index since the 1940s.

S&P 500 index since 1928

Don’t try to time the market

Timing is the bane of investors everywhere. We fear buying or selling at the wrong time. Given the volatility in markets, bad timing can cost you dearly.

Let’s illustrate this using a local example. We have two investors who we’ll call “Market Timer” and “Buy and Hold”. Both have R500 000 to invest. They are both high-risk investors and would like to invest in a local equity fund. They both start their investment journey on 1 January 1998 and they both invest in the same local equity fund.

Below, we illustrate the journey of these investors. Over their 25-year investment journey, both investors experienced eight drawdowns of more than 10%. The worst drawdown, of close to 40%, occurred in 1998 just as they started their investment journey.

Investment journey from 1 January 1998 to 30 June 2023

The two investors adopted different investment strategies:

  • After the first drawdown, Market Timer moved their investment into a money market fund, only to get back into the market after market volatility subsided and the fund reached its previous peak. They continued to do this at every drawdown, disinvesting from the equity fund into a money market fund and buying back into the equity fund when volatility subsided.
  • Buy and Hold remained invested throughout the period, not making any moves.

The results of these two different investment journeys are astounding. After 25 years, Buy and Hold ended with just over R14 million while Market Timer ended with just over R3.6 million.

Market Timer ended up missing the best days/months by deciding to withdraw and seek safety after a big drawdown in the market. This also acts as a good reminder that often the best days come after the worst in markets.

Buy and Hold rode the ups and downs, and simply let compound interest work its magic.

In fact, it would have served Market Timer better to just put their money in the money market fund and remain invested, rather than trying to time the market and switching out of the local equity fund to cash when there was a drawdown.

With this said, being invested in cash over your investment journey would be a sure way to not keep up with inflation.

Market Times vs Buy and Hold vs Cash

Mind the gap

The persistent gap between the returns investors actually experience and reported total returns makes cash flow timing one of the most significant factors ‒ along with investment costs and tax efficiency ‒ that can influence an investor’s end results.

In Morningstar’s Mind the Gap study, we dig into these nuances and explore how differences in the timing of cash flows, sequence of returns, and asset size can impact this gap.

The report found that fund investors earned a 9.3% investor return (which reflects the impact of cash inflows and outflows on the returns investors actually earn) over the 10 years ended 31 December 2021, while their fund holdings generated an 11.0% annual total return over the same period.

Therefore, investors suffered a 1.7% annual return shortfall, or gap, due to mistimed purchases and sales. This annual return gap is in line with the gaps we measured over the four previous rolling 10-year periods, which ranged from 1.6% to 1.8% per year.

Assuming compound interest, this is close to a 2% difference annually and can make a very large impact on your investment journey.

Simple strategy for building wealth

  1. Define your goals and develop a plan together with your financial adviser to achieve them.
  2. Save. You can’t invest money until you’ve saved money. Start as early as possible, a little bit can go a long way – remember compound interest is the eighth wonder of the world.
  3. Keep it simple. Don’t stray from your circle of competence. It’s all too easy to be lured outside your wheelhouse by friends, neighbours, or marketers. Complexity is costly and rarely yields benefits.
  4. Investing is a long-term pursuit – it’s not and shouldn’t feel like a trip to Vegas.
  5. Don’t try to time the market. Time in the market ‒ simply staying invested ‒ is undeniably the superior strategy.

These are your biggest ingredients for building wealth. These factors have nothing to do with picking stocks or a complex investment strategy. Get these big things right and any disciplined investment strategy should do the trick.

Warren Buffett famously said, “Investing is simple, but not easy.” Being a good investor does not necessarily mean hours spent researching a stock or investment. The crucial trait of a good investor is discipline.

This post was based on a press release issued on behalf of Morningstar South Africa.


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Maya Fisher-French author of Money Questions Answered


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