Timing Markets

Navigating Market Volatility by Timing Markets

With the financial markets often being unpredictable and volatile, the temptation to time the market – selling assets now to repurchase them later – becomes greater. However, even the most experienced investors find this timing impossible, leading to the wisdom: it’s not about timing the market, but time in the market.

Investor Emotions and Market Trends

Human emotions play a significant role in financial decisions. Market downtrends incite panic selling among investors, while uptrends trigger buying frenzies. Past experiences often dictate these reactions. Considering the six major market crashes within the past 30 years, it’s no surprise that investors’ psychology influences their decisions.

Behavioural Finance and Market Perception

Investing in a bull market isn’t always a smooth journey. Investors are consistently anxious about valuation levels, always anticipating the next market downturn. According to behavioural finance’s prospect theory, investors prioritise potential gains over the perceived risk of loss in uncertain investment outcomes. This theory relates to regret aversion and the fear of losses overshadowing the happiness from gains, leading many investors to panic sell during tough market periods. Therefore, it’s usually recommended that investors refrain from checking their investments daily.

The Pitfalls of Market Timing

Markets react quickly to news, incorporating the effects into stock prices almost instantaneously. As a result, those who try to time the market may end up missing significant market shifts. Predicting the future can leave you outside the market during unexpected upticks, possibly causing you to miss some of the best performing days, which could considerably impact your portfolio over time.

For instance, imagine a $100,000 investment in the S&P 500 Index from 1 January 2002 to 31 December 2021. An investor who stayed in the market throughout this period would have a final sum of $616,317. However, an investor who missed just five of the best performing days would end up with only $389,263.

The graph below also demonstrates what missing the best 10, 15, 20 and 25 days can also do to the same investment value.

Interestingly, most of the best market days occur near the worst ones. Over the last 20 years, 70% of the best 10 days happened within two weeks of the worst 10 days (Source: Factset). Therefore, incessantly entering and exiting the market can erode returns, incur tax implications, and increase transaction costs.

Even a broken clock is correct twice a day, but predicting market trends is not our speciality. If timing the market was a straightforward task, we would see a lot more investors retiring early on a lovely beach in the Caribbean. The key takeaway is that short-term volatility is the price we pay for the chance of higher long-term returns. The power of compounding will take effect if you resist the urge to make impulsive decisions and potentially crystallise losses.

Celtic Financial TV

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Important

This article is for information purposes only – should not be perceived as financial advice. We recommend you should always speak to a financial adviser before making any investment decisions.

Please note, past performance is not a reliable indicator to future returns. Your investment may fall as well as rise, and you may not get back what you put in.