Your risk profile is not only shaped by your psychological attitude toward risk, but also your age, goals & financial situation when investing.
2022 hasn’t got off to the best of starts for investors. Both stock and bond markets are down, and with inflation remaining high, potential interest rates rises on the horizon and worry surrounding the Ukraine conflict thrown into the mix, it’s understandable for many investors to feel nervous.
The natural reaction for some during times likes these is to sell their investments to avoid any further falls, then buy them back when things have calmed down and the outlook has improved.
This is ‘market timing’, where you try to anticipate when are good times to buy and sell. Sounds sensible enough you might think, but you could actually be doing your wealth more harm than good.
If there’s one chart to explain why investors shouldn’t try to time the market, it’s the one below. We took the past 1,000 weeks of global stock market returns and then showed what would happen if you missed just the ten best weeks – the top 1%.
The difference is stark. Missing just those ten best weeks meant your returns were 70% lower than being invested the full 1,000 weeks.
It doesn’t matter how experienced you are, there is no way on earth anyone knows when those 1% best weeks will come. What we do know though, is they tend to come – without notice – immediately after a period of negative returns. So nearly all of them are likely to have been missed by those not invested during volatility.
So if you’re thinking about selling during market wobbles, while you might avoid some of the falls (and there’s no guarantee you’ll even do that), you still could still end up worse off by missing out on the sharp recovery weeks.
Here’s a story about two imaginary investors – Jack and Eddy. Both are disappointed by recent market drops and worry about further falls. Jack is certain unless he sells his investments now, his portfolio will suffer even more and so sells them all. Eddy, while also feeling uncomfortable, knows markets go up over the long term so she decides to stay invested.
Imagine markets do fall further. Jack is feeling very pleased with himself. He’s avoided those falls and is now waiting for markets to settle down before investing again. Eddy’s portfolio falls with the market, but she’s still not going to do anything – selling now would only lock-in those losses. She’s going to patiently wait for the recovery.
The markets rise but performance is still erratic and Jack isn’t sure if more falls will follow, so doesn’t want to invest again just yet. Eddy’s investments, however, rise with the markets and her portfolio begins to recover.
A few months of rising markets later, Jack decides now’s the time to invest again. He’s missed a lot of the recovery but is still better off than if he hadn’t sold when he did. Jack’s certain he did the right thing. By staying invested the whole time, Eddy’s portfolio fully benefitted from the recovery, but didn’t do as well as Jack. She’s pleased with herself too though, for having the discipline to stay calm and stay invested.
Time passes and markets are getting jittery once more. Predicting another drop and full of confidence from his previous exploits, Jack sells all his investments knowing he’ll be safe again. Eddy sticks to her approach of staying invested.
This time it turns out to be a short-lived bout of volatility and markets recover quickly. Jack thinks markets are still too choppy and fears another drop could be around the corner, so he stays away. By remaining invested Eddy captures all of the recovery like last time, and is pleased her discipline has paid off once again.
Markets keep rising and Eddy’s portfolio keeps going up with it. Jack admits he got it wrong and invests again before he falls any further behind. By missing out on the gains, Jack’s jumping in and out of the market means he ends up worse off than Eddy, who’s steady and patient approach means she fully benefitted from all the rises. Jack concedes he should probably give up trying to outsmart the market.
Investing isn’t a series of sprints. It’s a marathon that for most will last several decades. In that time you can be certain there will be times when things don’t go to plan. If you panic at the first sight of trouble though, or try to outfox the market, sure you might get it right once or twice. Try getting it right time after time over decades though. You could find out the hard way it’s nearly impossible.
The solution is simple: stay invested. You won’t have to worry about if now’s a good time to sell or buy back in. Accept markets will fall, and occasionally dramatically, but keep in mind they go up more often than down and have always recovered given enough time.
Time is investors’ most powerful weapon. The longer you invest the longer you can let compound growth (which Einstein called the “eighth wonder of the world”) ramp up your returns. Miss out on any of that time in the market and you could be putting a serious dent in your portfolio’s long-term performance. So which will you be: a jumping Jack or a steady Eddy?
Past performance is not a guide to future returns. Investment involves the risk of loss and the advice herein cannot be construed as a guarantee that future performance will be reflective of past returns.
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