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When markets move sideways, some investors may choose to stay sidelined in cash until the market starts moving again. Is this the best strategy?
Key
Points With
this limited movement in the stock markets since the past few months,
some
investors may be tempted to sit on the sidelines, waiting for the next upward
movement before
investing in the stock market. Is the practice of trying to time the market really the best option? Let us evaluate it! Market
timing study We
consider the historical data for
the BSE SENSEX to capture the numerous
economic cycles between 1980 and 2009. The purpose is to monitor the
stock market
outperformance of an investor who has managed to avoid either daily or
monthly
declines in the market. Table
1 shows the returns obtained by missing the best and worst ten days, as
well as
the best and the worst ten months for the entire period (end of
December 1979
to end of October 2009).
Setting
more realistic expectations The
results we have derived so far suggest that the investors who can
successfully
time the market (either by month or by each day) may become a
millionaire, or
even the richest person in the universe. Obviously, the catch here is
that it
is practically impossible to time the market on a monthly basis with
perfect
accuracy over such a long period of time. Needless to say, timing the
market
with perfect precision on a daily basis over twenty nine years is
perhaps an
art best reserved for the almighty. Table 2 shows the same study with more realistic scenarios. Four scenarios were tested, which we believe are plausible outcomes for an individual investor.
Avoiding
the “mines” or “potholes”
obviously increased
returns Avoiding
the ten worst months has increased the annualised returns from 18.4% to
26%,
while avoiding the ten worst days increased the annualised returns to
22.4%.
This is all well and good for an investor, but it certainly calls for
the
question: how does an investor manage to avoid these
“potholes” in their
investment journey? But
missing the best months or days severely impacted performance Being
unable to forecast the future, we believe that our study of missing out
on the
top ten months or top ten days may have more bearing on determining the
investment approach. In the entire 368 months of study, it is
surprising to
note that missing out on the best ten of those months nearly halved the
actual
annualised return of the SENSEX. On an absolute return basis, the
13,453%
return of the SENSEX was cut to just 1,341% as a result, a very paltry
return
for almost twenty nine years of investment. Missing
out on the best ten days of market performance in the entire eighty-two
year
period was less detrimental, but cut the annualised return to 14.2%
versus the SENSEX’s
18.4%. On a total return basis, this has translated to a 4,757% return. Markets
are “boring” a large part of the time As
shown in Chart 1, the monthly returns of the SENSEX appear to be
normally
distributed, with 68% of the monthly returns in the range of -5% to 5%.
These
are the periods where markets are considered
“boring” and
often trade in a
range bound fashion. However, we believe that the investors should be
more
excited about the positive occurrences (those on the right side of
Chart 1),
and should ensure that their portfolios benefit when such hefty gains
occur. Unless
one is extremely lucky, the only way to ensure exposure to these
positive
periods of performance (just 11.5% of the months under study had a
positive
return of over 10%) is to remain invested in the stock market and avoid
timing
the market. Staying
invested is the better option From
the results, it appears that while getting market timing calls right
(avoiding
worst performing days or months), one can generate significantly better
performance than the market return. On the other hand, missing out on
the best
days or months will hurt returns substantially. Since no one can correctly forecast the direction of the market with precise accuracy, avoiding the worst periods of performance is not easy, and is sometimes an impossible task. Rather than trying to avoid the large negative-return outliers (shown on the left side of Chart 1), a task fraught with uncertainty, investors can choose to “accept” all the huge positive-return occurrences (on the right portion of Chart 1), a certainty if one stays invested in the market. Related Articles:Interpreting Market Indicators Understanding Leading Economic Indicators How to Avoid Losses In a Volatile Market? |
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Terence Lin is part of iFAST Financial Pte. Ltd. & Manjunath Gaddi is part of iFAST Financial India Private Ltd. | ||||||||||||||||||||||||||||||||||||||||||||
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iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website. | ||||||||||||||||||||||||||||||||||||||||||||
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