By Rebecca Ellis
TUE, SEPT 01 2020-theG&BJournal- Investing in the financial markets is like driving your car with visibility being so poor, it feels as if you were driving in fog. Looking out the rear-window or at best the out of the side window of the car does not help. You need to look out of the windscreen in order to have the best chance of driving safely. The trouble with this is that you cannot see any signposts or guard rails. What can you do?
Statistics offer some guidance: On average, going back one hundred years, the stock market falls 10% once a year. It falls 20% every four years, and it falls 30% once a decade. Last March, the stock market fell 30% and that was a shocking occurrence. The market was more volatile than it has ever been, but it was the first 30% decline in 12 years (not 10 as the statistic would show).
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Equipped with this statistical knowledge, investors, private and professional alike, set out to anticipate these corrections. What they try to do is holding back investment or taking some or all their money out of the market when they anticipate a fall: this is called timing the market and it comes in many forms:
I am building up cash so I can invest at the right time.
The market is too crazy to invest right now.
Why would I invest now, when a recession is on the horizon?
Sound familiar? Such approaches to investment are almost all futile. Markets are second order systems. What this means is that in order to successfully implement such market timing strategies you not only have to be able to predict events — interest rate rises, wars, oil price shocks, the impact of the coronavirus, the outcome of elections and referendums — you also need to know what the market was expecting, how it will react and get your timing right. Tricky.
Remember when Donald Trump was elected president, all market commentators told us that the markets would tank. Instead, they rose.
Investors who try to time the markets often sell far too early. Therefore, they miss out on some of the richest returns. Selling stocks when everyone is still buying may be the easy bit. It is harder to find the nerve to buy stocks when others are selling them in a panic. Without the benefit of hindsight, timing produces disappointing results.
The longer you hold on to a stock, the better your odds of realizing a positive return on your investment. By contrast, holding periods of less than one year, regardless of the stock, have much greater risk, to the point that if you are only holding stocks for a period of a few days or a few weeks, you might just as well flip coins in the alley. And that is not even considering the tax ramifications and trading costs that go along with frequent trading.
Although stocks are sometimes considered risky investments, their long-term gains have been demonstrated to offset short-term losses. Illustrations of this provided by Morningstar are too big to show here but demonstrate this point quite nicely – and are available upon request.
-Of the 94 one-year periods since 1926, 25 have resulted in a loss.
-Of the 90 overlapping five-year periods since 1926, only 12 have resulted in a loss.
-Of the 80 overlapping 15-year periods since 1926, none have resulted in a loss.
To quote Warren Buffet: “In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
In other words, driving in fog is difficult and we agree. What can you do? Devise a plan, drive slowly but keep going and you will reach your destination safely.
Rebecca Ellis is a Personal investment advisor, based in Zurich