With more data and market insight available than ever before, investors can be tempted to ‘play’ when the good times are looming and withdraw when the panic hits. But are they better off staying in for the long haul – and reaping the benefits of the few good days a year?
The coronavirus pandemic has created extreme market volatility. The FTSE 100 dropped by more than 10% in a single day – its worst day since 1987 – while in the US, the Dow and S&P 500 were also hit by their steepest daily falls since 1987. As packages of aid and other financial support were announced by governments, the markets responded accordingly, creating wild fluctuations in market activity.
Of course, these extreme volatilities are unusual and rare. So, when the markets are in their more ‘normal’ state of activity, what’s the best way to play them?
Rebecca Bettany, Head of Jersey-based JTC Private Office, had a client who summed it up beautifully: “All I want you to do is buy things when they’re cheap and sell them when they are expensive.”
That, in a nutshell, is market timing – the art, or some would like to think, science, of predicting when prices are about to go up and when they are about to go down, and trading accordingly.
After years as an asset manager, Bettany’s role now involves supporting clients – wealthy families and family offices – with their investment strategies, including writing investment mandates and choosing managers.
But if clients are tempted to time the market, she advises: “Markets are unforecastable. If you’re out of the market for the best 10 or 20 days in any given year, you may as well not invest at all.”
Making money from buying and selling shares would be easy to do if you had the benefit of hindsight. The trouble is that not even the most hardened investment professionals know what’s going to happen next.
As Terry Smith, founder and CEO of Fundsmith Equity Fund, has explained it, data on investment behaviour shows that, in practice, people tend to follow a herd instinct – with money flowing into funds and other assets when they have risen, and flowing out when they have already fallen. That is exactly the opposite of what market timing would hope to achieve.
“It’s not hard to see why we are almost all bad at market timing,” said Smith. “It’s hard enough to have the strength of conviction to convince yourself that markets are too high and sell when the background is looking rosy and everyone else is bullish.
"But it requires an extraordinarily flexible psyche to be able to complete the required volte face at the bottom and buy the stock, market or fund after your predictions have come true, its prospects look bleak and the price has fallen.”
Paying the price
The consequences of getting the timing wrong, and not being invested when the market rallies, can be eye-watering.
Figures from Fidelity International show that somebody who invested £1,000 in the FTSE All Share on 21 February 2000 and stayed invested over the whole period of the next 20 years would have generated a total return (including the initial investment) of £2,817.83.
Had they missed the 10 best days over that period, however, the result would have been just £1,524.85. And had they missed the best 20 days – an average of just one day a year – the return would have been reduced to £1,006.68.
“These figures highlight the importance for investors of taking a long-term approach,” says Ed Monk, Associate Director at Fidelity International. “In times of market turbulence, it can be tempting to retreat – moving money to cash to avoid a further drop in the value of investments.
“But market movements are an inevitability for anyone invested over a number of years. Often the best thing to do is steel your nerves and stay in the market, rather than dipping in and out. Our analysis shows that the returns generated by time in the market far outweigh those generated by seeking to time it.”
Many investors are tempted to sell when news is bad and prices are falling, adds Monk. However, they should ask themselves when they will buy back into the market, as it only makes sense to do so when news is uncertain.
“That’s the hard bit about trying to time markets,” he explains. “You don’t just need to get one call correct, you need to get two. Selling out is the easy bit because you can do it and swim with the crowd at the same time. Buying back in, on the other hand, requires a contrarian approach that few, when it comes to it, are comfortable adopting.”
When there are anxieties about a market crash, the temptation to sell up is especially strong. With fears about the effects of coronavirus spreading in late February, Bettany says: “We had a few clients who expressed a wish to liquidate their portfolios on the back of the virus, to which I didn’t agree.
"In some of these cases, we went ahead and liquidated because that was the client’s ultimate wish, but personally I would stick firm.”
Pros and cons
Arguably, if you believe that game-changing global events could leave the market in the doldrums for years to come, or if there’s a bubble that means a particular category of shares is inflated wildly beyond its true value, selling could be the right thing to do.
That’s what happened with the dotcom bubble in the late 1990s. Most of the over-hyped early internet stocks never recovered anything like their peak valuations in 2000 after prices started to fall.
But Andrew Prosser, Investment Manager at Brooks Macdonald, says: “Bubbles are easy to identify in hindsight, but much more difficult to identify in advance.” The real key to avoiding the impact of a bursting bubble in a portfolio, he says, is to maintain diversification.
On the other side of the coin, significant market corrections – especially when triggered by events whose effect proves to be shortlived – can be the best buying opportunities for those willing to take a contrarian approach.
Technical, data-driven strategies are used by some investment managers to time their interventions in the market – for example, identifying when a share price deviates from its long-term moving average, or the balance between buyers and sellers.
The trouble is, aside from the fact that these are best left to professionals, stock markets often don’t behave rationally.
And it’s hard for any individual to compete with automated trading systems that make decisions using algorithms and can make trades in tiny fractions of a second. That becomes particularly crucial when the market is volatile.
In it for the long term
At the heart of the matter is how long you should hold investments. Ups and downs in the market of a few percentage points can look significant at the time, but become tiny blips when performance is charted over a longer period of 10 or 20 years. “As a general rule,” says Prosser, “time in the market beats timing the market.”
One of the main reasons for this is the way in which returns are compounded over the long term. He gives an example: “At a 7% rate of return, a £1 investment grows to £1.31 over four years, but over 40 years grows to £14.97. It’s only after investing for a decade or more that clients can really start to see the benefits of compounding.”
Research published by Andy Haldane, Chief Economist at the Bank of England, however, has shown that the average holding period for shares in the UK fell from almost eight years in the mid-1960s to just 7.5 months by 2007 – and has probably fallen further since.
So, those managing investments on behalf of private investors and families in the Channel Islands may need to educate their clients and encourage them to see the benefits of long-term investing.
Bettany adds that, before you invest, you should take out what you need for running costs over the next three to five years, then choose the best managers and be prepared to pay them well. “The market rewards you for the amount of risk that you are willing to take,” she says. “And part of that risk is not being able to get your money back immediately. At the end of the day, markets are not for everyone.”