Time in the Market vs. Timing the Market – Investing through Market volatility
Time in the Market vs. Timing the Market – Investing through Market volatility
Introduction
The instinct to act impulsively, either driven by the thrill of potential gain or fear of loss, often leads investors in a way that undermine long-term returns. Psychological traits such as overconfidence and ‘The Recency Effect’ (exaggerating recent events to disproportionately influence decisions) can lead to investors believing they can predict market movements.
What is ‘time in’ the market? What is ‘timing’ the market?
Although the phrase itself is somewhat a fun play on words, it depicts an important aspect of investor sentiment. It intends to show how patient investors are rewarded for their resilience during difficult market periods by reaping the rewards during market recoveries. This contrasts with ‘timing’ the market where investors try to benefit from buying and selling their investments based on market conditions.
The history of remaining resilient
During the COVID-19 outbreak in March 2020, investments fell heavily, leading many investors to panic and move their portfolios into cash. Conversely, those who stayed invested experienced a significant rebound.
We have also seen this more recently in April with the shock reaction to the US trade tariffs. The immediate aftermath of this announcement saw equity markets fall significantly. However, in the three months between the announcement, the US stock market has risen by over 25% and the FTSE 100 has recently reached new all-time highs.
The power of long-term investing
Investing in stocks and shares is associated with capital growth in the long-term; but this can only be achieved if investments are allowed to grow over the long-term. There are two key factors for this:
- Compounding returns
Compounding returns can be an extremely powerful tool whilst investing and is mainly referred to as an act of ‘earning interest on interest’. Since compound interest includes interest accumulated in previous periods, it grows at an ever-accelerating rate. This tool is especially relevant when thinking about long-term investing as longer periods allow for greater compounding potential.
- Riding out volatility
Market volatility is an inevitable aspect of investing. Although the unpredictability can be uncomfortable at times, it is always important to remember the bigger picture of returns over the long-term. Riding out market volatility is important because some of the best returns can follow downturns – cashing in during difficult periods could result in someone experiencing all of the downsides (values falling), then missing out on the following upside (markets recovering).
The risks of timing the market
As much as everyone would love to adopt a ‘buy low, sell high’ strategy, this is much easier said than done. There are some significant risks when trying to ‘time’ stock market participation:
- Missing the best market days
The cost of missing the best days in the market is high, and the value of staying invested cannot be overstated. Numerous factors, such as economic indicators, political events, and investor sentiment, make the markets highly unpredictable. As shown in the graph below, waiting for the right time to invest or tinkering too much with your investments can mean you miss the markets’ most fruitful days.
The graph compares the difference of staying invested (black line) and missing the best 10 market days (green) over a 21-year period.
Source: Waiting for the right time to invest | Hargreaves Lansdown
- Emotional investing
Impulsive decisions such as panic selling, chasing trends or ‘herd mentality’ are all actions associated with emotional investing. These are driven by feelings of fear, greed, or anxiety, rather than solid data and strategy. Our emotions are powerful, and these reactions can severely impact an investor’s portfolio.
- It’s expensive
When we try to ‘time’ the market by buying and selling shares, we entail higher transaction costs, such as broker commissions and bid-ask spreads. These costs can erode investment returns over time.
Conclusion
It is easy to fall into the trap of reacting impulsively in times of market decline. However, by remaining invested over the long term, you have a greater chance of riding out any short-term market fluctuations. Maintaining a long-term view is imperative; investment performance should not be analysed over a week, a month, or even a year, it is worth remembering the bigger picture.