The U.S. stock market is off to one of its best starts in history, but let’s not forget that 2018 was marked with increased volatility that caused many investors to consider exiting the markets, especially during the last quarter of the year. Let’s be clear, it’s very tough to outsmart the markets. Trying to time the market on a consistent basis has proven to have a snowball’s chance in hell.
The consequences of missing the best days or months of the market could be hard to digest. The following table illustrates that fact. An investor who missed the very best month of the S&P 500 Index in the span of the last 351 months, experienced an annualized return of 8.98%, compared to a 9.62% annualized return for an investor who stayed invested during the entire period. That would have cost $232,673 of the final value of a hypothetical initial investment of $100,000. The results are far worse for someone who missed the best 5 months over the same period.
The aforementioned case is tantamount to the theory of risk/return profiles improving with time. If an investor repeatedly aims to time the market, it’s likely that, rather than selling high and buying low, the results turn out to be just the opposite.
Long-term gain probabilities are maximized with time, not timing. I took the same data used above to come up with the probability of a gain or loss if an investor picked a random day during the period. Not surprisingly, an investment for just that one day would have had a 53.29% chance of a gain. If the holding period is increased to one week, the probability of gain increases to 56.06%. Not a huge difference, but wait, if we then increase the holding period to one month, the probability of profits goes to 62.68%. With quarterly and annual data, the probability keeps increasing to 68.10% and 79.31%, respectively.
What may be perceived as a stressful big move in the market for a short period, in the grand scheme of things, it could be in fact just a natural blip. The historical data should not mislead investors into perceiving long-term investments as a risk-free case. In fact, investment risk cannot be eliminated, but certainly can be managed with a disciplined strategy.