Just stop it. Don’t try to pull your money out in fear of a dip, because you won’t win.
The post Warning: 2 reasons why you can’t time the market appeared first on The Motley Fool Australia. –
There’s no doubt ASX shares have been shaky the past month.
The S&P/ASX 200 Index (ASX: XJO) has plunged 5.5% since its 13 August high, sending it ever so close to correction territory.
And we’re now into October, which is traditionally the ‘month of crashes’.
“Think back to the Wall Street Crash of October 1929, Black Monday of October 1987, the Great Financial Crisis that started in October 2007,” said Switzer Financial director Paul Rickard.
“…or even the “mini-crashes” of 1989, 1997 and 2002.”
What changes should we make to our ASX shares?
With such a dip, it’s tempting for investors to fiddle with their portfolios.
But stop it.
Since the dawn of time, experts have warned stock investors to not try to time the market. And that message is especially vital during turbulent times like this.
AIM Funds, in a recent memo to clients, stated its team always remembers one piece of old school advice.
“There are two types of investors when it comes to market timing: those who cannot do it, and those who know they cannot do it.”
Investing is a long-term game of compounded returns, and trying to time the market is antithetical to that.
“Investors will only enjoy the effect of the compounding process if they remain invested for the medium to longer-term,” the memo read.
“An investor’s friend is time, conviction, fundamental research and a business ownership mindset.”
If someone makes money out of timing the market, it is a rare fluke — because logic and history dictates no one can do this intentionally and consistently.
AIM’s memo pointed out a couple of reasons why short-term timing never works.
Missing the biggest market rises
Firstly, selling out in anticipation of a correction or crash inevitably leads to missing out on stock rises.
“Not surprisingly, the big ‘up’ days tend to be clustered around the big ‘down’ days during periods of increased volatility,” the memo read.
“Giving in to the temptation to ‘get out’ on the big down days dramatically increases the risk of missing the rebound.”
To demonstrate this, AIM cited a JP Morgan study where a hypothetical $10,000 was invested in the S&P 500 Index (SP: .INX) on 3 January 2000.
That amount would have become $32,431 by 31 December 2020, which equates to a yearly return of 6.06%.
“Missing the 10 biggest ‘up’ days cuts that compound rate of return to 2.44%, while missing the 20 biggest days reduces it yet further to a paltry 0.08% per year.”
If you miss the 30 best days, that portfolio actually goes backwards over those 21 years, ending up with a negative -1.95% return per year.
“‘Getting out’ to avoid the psychological pain of short-term paper losses is not worth the increased risk of long-term damage to returns, in our opinion.”
Stock markets are second-level systems
The AIM team also pointed out that share markets are “second-level systems” that are impossible to predict correctly.
“It is not enough to accurately predict an event; one must also correctly predict what the market was anticipating prior to the event and then correctly deduce how the market might react to the new information,” the memo read.
“We think that getting all 3 of those variables correct – and then being right on the timing, to boot – is nigh-on impossible to do [repeatedly].”
Corrections, pullbacks and crashes are all an “unavoidable” part of investing, according to AIM.
“When seen in perspective as a period of prudent capital allocation with a margin of safety, is more likely to provide opportunity than lasting damage.”
Again looking at the S&P 500 as an example, it has copped a correction of 10% or more 36 separate times since 1950.
“If there have been 36 double-digit drawdowns over the past 70-odd years, it works out that investors should expect this to happen with a frequency of about once every 2 years.”
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Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.