1888PressRelease – Mark Tanner Full Circle Financial Group Hong Kong talks about he value of taking a long term approach to investment.
Bad timing is one of the big risks of investing in stock markets but there is a simple way to diminish this danger – provided you give your investment sufficient time to do so.
Most people can understand the risk that share prices might fall after they have invested. Fewer people are likely to have considered the risk that total returns might also be reduced by failing to be invested on key days and other periods when share prices are rising.
Both risks are forms of bad timing and both are caused by the fact that share prices can fall – or rise – without warning. It is impossible for investors to be sure in advance whether prices will fall or rise after they buy shares, for example in investment trusts – or any other asset traded on the stock market.
Because the first step toward making a profit is often to buy low, potentially the best or most profitable days to buy shares are often immediately after prices have fallen. By contrast, it could be suggested that the worst or least profitable days to buy shares are often immediately after prices have risen.
Because investor confidence tends to fall when share prices are falling – and to rise when share prices are rising – there is a temptation for investors to do the exact opposite of the first step toward making a profit. They stay away from shares when prices are low, and most likely to prove profitable, and to buy shares when prices are high, and most likely to lead to losses.
If all that sounds somewhat theoretical, then consider the cash consequences of being ‘out of the market’ or not invested in shares during just the 10 best days during the last decade, as measured by the FTSE All Share index – a broad measure of the London Stock Exchange – which was formed in 1962 and now tracks more than 700 share prices. Someone who invested £1,000 in this index on August 31, 2004, and left this sum fully invested throughout the 10 years that followed, with dividend income reinvested, would have had a fund before charges equal to £2,328 by August 31, 2014.
However, if this investor missed just the 10 best days during this decade – and by this I mean hypothetically not being invested in shares for only one day each year for 10 years when share prices increased the most – then the total return during this decade would have plunged to £1,271. If the investor missed just the 20 best days, then they would have suffered a loss by the end of the decade – turning £1,000 into £872. Where they missed the 40 best days – still only equivalent to the best four days each year – they would have lost more than half their capital, ending the decade with just £484.
This demonstrates why short-term speculation – or attempting to ‘time the market’ by ducking and diving into and out of assets with volatile and unpredictable prices – may prove more risky than long-term ‘buy-and-hold’ investment. Please remember that the value of investments and the income from them may fall as well as rise and you may not get back the full amount invested.
The past is not a definite guide to the future. However, as in any walk of life, some knowledge of history may help us understand the present and even provide some sort of basis to consider what might happen in the future.
There is other evidence to suggest that the longer you can afford to remain invested in shares, the less likely you are to be forced by personal circumstances to sell at a loss when prices are temporarily depressed. This strategy to cope with share price volatility is one reason why it is sometimes said you should not invest any money in the stock market that you cannot afford to leave invested for at least five years.
While most shares can be bought and sold any day the market is open, a second piece of analysis – this time based on more than a century of returns – suggests that the probability of making a profit tended to increase the longer shares were held. For example, shares representing the broad composition of the London Stock Exchange delivered greater returns than cash deposits or gilt-edged bonds in more than two thirds of all the periods of two consecutive years between 1899 and 2013. Looked at another way, in nearly one-in-three of these periods of two consecutive years shares failed to beat cash or gilts.
When the period of investment was lengthened to five consecutive years, shares beat cash three quarters of the time – that is, in 75% of these periods – and beat gilts over 74% of these periods. Looked at the other way, although not a like for like comparison, it’s worth making the point that the risk of underperforming cash or gilts fell from nearly one in three to one in four. Please note that shares are riskier than bond and cash investments.
Where the period of investment was lengthened to 10, the historical probability of shares beating cash increased to 90% and the equivalent figure for gilts was 79%. Where investments were held for 18 years – which happens to be the minimum term for child trust funds – the historic probability of shares beating cash rose to 99% and the equivalent figure for gilts was 88%.
Even so, with several stock market indices hitting all-time highs some potential investors may fear an imminent setback where share prices might fall sharply, which – as mentioned earlier – could happen without any warning. But a third piece of research based on actual market returns suggest that short-term volatility may not matter to long-term investors – such as pension savers – so long as they are not panicked into selling after share prices fall and remain invested until the market recovers.
For the purposes of illustration within the research – and to breath life into dry statistics – let’s call this the tale of ‘Bad Timing Bob’, the man who only ever invested at the top of the market. His terrible timing was offset by the fact that he was a regular saver who stuck to his plan. He began saving aged 22 in 1970, setting aside £1,000 a year during that decade and bumping up his annual savings by £1,000 each decade until he could retire aged 65 at the end of 2013. So, that’s £2,000 a year in the 1980s; £3,000 a year in the 1990s and then £4,000 a year until he retired.
Remember that Bob only ever invested at the top of the market. So, just before the oil crisis of the 1970s pole-axed share prices, he invested the £3,000 he had saved in 1972. Bad Timing Bob then watched the FTSE All Share index – a broader measure of the London market than the FTSE 100, which didn’t start until 1984 – collapse by 60% between 1973 and 1974.
Not an encouraging start, I think you will agree, but Bob’s saving grace – quite literally – was that he never sold. He knew he wasn’t wise enough to choose the right time to buy – indeed, he always chose the wrong time – but he remembered that his objective was to fund retirement and so he never tried to find the right time to sell.
As a result, even though he invested just before stock market setbacks – including ‘Black Monday’ in 1987; the bursting of the dot.com bubble in 2000 and the credit crunch in 2008 – he ended the 40-year savings period with a pension pot worth more than £632,000 (not including costs). Not a bad return on total investments of £112,000.
He never sold when share prices were depressed and thus benefited from the long-term upward trend in share prices and compound interest on dividend income. Bad Timing Bob’s example shows us that short-term stock market setbacks need not matter much to people willing and able to take a long-term approach to investing in the stock market.