Hey there and welcome back to Ireland's #1 personal finance blog. This week we are exploring what is quite a common challenge for people, the decisions about investing a lump sum now or waiting for markets to fall or crash. Funnily this is not usually a challenge for would-be investors when markets are calm and rising. It more often becomes a challenge when market volatility hits, or when media is claiming that the market it 'over-priced' or at an 'all-time high'.
The Impact Of Time
In considering this it obviously makes sense to consider what the intent is with investing. When doing a presentation last week for a group of advisors I asked them what the main purpose of investing is, 50% of the room said it is to beat inflation, while the other 50% of the room said it was to achieve decent growth. If you are considering an investment perhaps it is worth considering what your intent is with that investment. I firmly believe that unless there is a clear goal or plan for the funds then you are much more likely to make decisions that would be detrimental to your long term investment success. We can never obviously predict what the future holds for markets, and that history may well not repeat itself, but history (and the constant upward curve!) are all that we have to go on.
One piece of data I particularly like relates to the impact of time in the market, as opposed to timing. It analyses the Standard & Poors 500 (S&P500) between 1926 and 2011, and determines what percentage of rolling periods had positive returns, for various durations in that market.
1 Year - 73% of rolling periods positive (752 of 1021 rolling periods)
5 Years - 86% of periods positive (844 of 973)
10 Years - 94% of periods positive (860 of 913)
15 Years - 99.7% (851 of 853)
20 Years - 100% of periods positive!
These numbers basically speak for themselves here but to quickly look at both ends, 1 year and 20 year periods. We can see clearly that we stood a fairly decent likelihood of our investment being in positive territory after 12 months, but certainty of positive returns if we had invested for a 20 year period. Not everyone will have a 20 year window over which to invest but there is no denying that it clearly demonstrates the old and over-used mantra of 'its not about timing the market, rather time IN the market'!
Does It Pay To Wait For A Crash Before Investing?
The above points to the suggestion that it really doesn't matter where the market is at when you invest, that it should be in a gain position provided you can leave it for a certain period of time, irrespective of what happens in the short-term. Despite that implied fact, if you are of the view that perhaps you should wait for a down-turn in prices before investing you might be interested in another piece of research that was conducted. This piece of research I first came across when mentioned in an Irish Times article last year. The really interesting research was done by Elm Partners in the US and looked at what happens the S&P in the 3 years after every time it hit a level over the course of 115 years that can be defined as 'expensive' (as defined by the Cyclically Adjusted Price-Earnings Ratio, or CAPE ratio). The following are the core 3 findings of their research.
- Following an 'expensive' point, there was a 56% probability that the market goes on to have a 10% correction within 3 years, waiting for which would result in about a 10% return benefit versus having invested right away.
- In the 44% of cases where the correction doesn’t happen, the market rises leading to an average opportunity cost of about 30% – which is significantly higher than the average benefit of waiting
- Putting these together, the average expected 'cost of waiting' for a correction was about 8% versus investing right away.
Essentially there's a 50/50 chance of it falling by 10% or more, if you are holding out for that fall there is an almost equal chance that the market would have gone up by 30%, and on average you'd have been 8% better off getting in as opposed to waiting. But investors don't care about what has happened 'on average' in the past, they want to know what will happen in the near future and how they will stand to benefit! There's no crystal ball unfortunately!
What If The Market Falls After Invest?
You might be thinking, well all the research in the world is great but it isn't a prediction of what might happen in the future, and that there is still a solid likelihood that there will be a decline shortly after you invest, and that you might have been better-off holding out for a while instead of investing. Perhaps you would, but like anything in this it is simply impossible to forecast that accurately. It may go up, it may go down or it may stay as it is! However what happens if you invest and the markets subsequently fall?
The last quarter of 2018 is a fine example of that. There was a lot of market volatility, fear, speculation and negative coverage, which is what creates lack of confidence, which causes people to sell holding of equities, which causes prices to fall, in its simplest form! Let's track what would have happened an investment in a Global Equity Index, which tracks the entire global stock market, tracking 1600 of the world's largest companies, spread proportionately across the worlds primary equity markets.
Had you invested €200,000 in this on the 1st September 2018 and checked your investment balance on Christmas Day you value would have showed €170,000, down 15% on what you had invested. If you checked it again on 12th January it would be showing a value of €180,000, up 6% approx on the low of Christmas Day.
However had you by some festive miracle invested instead on Christmas Day the value would have risen to €212,000 on 12th January 2019.....your initial investment up by 6%. But even this tiny window of time is a perfect example of the challenges one faces if they are trying to 'time' the market.
Firstly, we had no way of knowing that the bottom of that very short period of volatility was going to be on Christmas Day, plus you would have probably have had to get the transaction in motion at least a day prior to the purchase date, God knows how you'd have managed that.
Secondly, at what point in a market decline will you say 'yeah, now is the perfect time' to get in. More often than, in the past, the market has already recovered before people are happy to invest, and so they have missed the lowest point (the cheapest price). Historically the swing from lowest point upwards happens in a very small number of days, and if you miss those you are missing the vast bulk of the returns of the market. JP Morgan do some fantastic research and I love their 'Guide to Retirement'. Between 1995 and 2014 they say that the S&P500 delivered just shy of 10% annualised return. However had you missed the 10 'best days' during that 19 year period due to your poor timing your return would have been 6% annualised. Had you missed the 20 'best days' your annual return is in smithereens at 3.5% annualised.
In summary, as much as we might want to miss the 'worst days' it is clear to see that we miss the best days at our peril!
If you are consumed with the debate about when to 'get in' might I encourage you to consider the above points. You may still feel that you would be better-off to wait for another decline, and one of more significance than we saw in December, and indeed for all we know you may not have to wait very long, and that is your prerogative of course.
What might be also useful is to focus on when you plan to 'get out'. Timing our exit from the investment will likely have far more of an impact on our return than our timing of entry. If history is anything to go by, if we can behave ourselves when the market takes a serious nose-dive, and we are patient, the constant upward curve of the great companies of the world have yet to let an investor down.
Choosing when to exit, and at what price to do so at is something that we CAN control, and if we do that right we can give ourselves every chance of being successful in our long-term investing.
I'd love to hear your feedback, questions or suggestions, mail me here
Paddy Delaney QFA RPA APA Coach