surinenglish

The cost to investors of stepping out of the market

Markets are made of people. As a result, movement of market prices ultimately reflects collective human behaviour, greed and fear, endeavour and ambition. Global stock prices continue to rise, and many are now at historic highs. This asset price inflation has attracted many speculators who see an opportunity to make money quickly, but for a speculator to be successful, they have to be right three times: 1) the price at which they buy, 2) the price at which they sell and generate a profit, and 3) the price at which they will re-enter the market and buy again. Study of investors’ and speculators’ behaviour shows us that no one can do this successfully with any degree of consistency.

As prices continue to rise, investors and speculators become increasingly fearful of a market crash. The fear of losing accumulated capital is real, as is the fear of losing out should prices move much higher.

For a genuine investor, it is notoriously difficult to allocate capital after selling and to judge when prices have fallen sufficiently to justify buying back into individual securities or the market.

Market prices move in cycles and eventually revert to the mean over time. For long-term investors, cashing out of the market may give temporary peace of mind. For a time, they are sitting on a healthy profit and riding out the inevitable storm, until the anxiety of when to buy in again becomes real.

The investors’ enemies are inflation and taxes, which can erode and eventually destroy accumulated capital. In the current cycle, negative real yields on bonds and cash erodes future purchasing power of capital. Detailed study of market history shows that the cost of not being invested during times of severe price declines considerably impairs an investor’s returns on capital over the long term.

If an investor misses the best 10 days out of 36 years, which is 10,000 trading days, the average compound rate of return is reduced by 19%. Missing the 20 next-best days reduces returns by an additional 17%. If only we could know these days in advance! Missing the best five days out of 72 years of market history would reduce cumulative returns, without dividends being reinvested, by nearly 50%! If an investor missed the best 10 days during the past 112 years, they would have missed two-thirds of the total gains available. Just think about this for a minute.

Sensible investors with a long-term preference take a measured approach, stay fully invested and ride out the storm. Resisting the temptation to chase Walter Mitty profits out of fear or greed puts the odds of successful investment outcomes in their favour. However, this requires mental fortitude and absolute conviction in a well-thought-out investment strategy. Because the stock market does not know that you own it and doesn’t care, benign neglect is the antidote to impulse.

To remain in the market and stay the course will put the odds of long-term success in the investor’s favour.

The author is a member of the Society of Trustees and Estate Practitioners and an investment counsellor. The comments and observations by the author are a reflection of his opinion and do not constitute an offer to buy and hold securities, nor does he receive any remuneration of any kind from names referred to.

The author can be contacted at jb@ehh.gi