Financial Planner Roy Ritchie explains the importance of holding your nerve when markets are volatile.
I think it is fair to say that we entered 2022 with a feeling of optimism that was not present at the start of 2021. Whilst the global pandemic was, and still isn’t over, life was starting to return to something like normal. Unfortunately, the light we were seeing at the end of the tunnel was actually a train coming down it in the form of one Vladimir Putin.
We are all aware of the immense humanitarian crisis caused by the Russian invasion of Ukraine. The impact on global investment markets has been equally significant, as they grapple with heightened volatility and the impact of spikes in inflation due to increasing commodity prices.
For those old enough to remember Dad’s Army, at times like this you can either subscribe to Private Fraser’s philosophy ‘we’re all doomed’ or Corporal Jones’s of ‘don’t panic’. We would encourage ‘don’t panic’!
The urge to sell when things look bad is perfectly normal, but it is important for investors to consider that this is not the first crisis to affect global investment markets (and unfortunately won’t be the last), and yet, the markets are still here. Ups and downs (or volatility as we refer to it) is inevitable over the lifetime of any long-term investment strategy, and seasoned investors will know that sometimes all you can do is ride out the storm. In the words of our American cousins: ‘this ain’t our first rodeo’.
There are those who believe the opposite though – that timing the markets is the key to success, and therefore you should sell while the going is good and buy back in once the markets have stabilised and are back on the rise (you will likely be familiar with the phrase ‘buy low, sell high’). This is known as trying to ‘time’ the markets, which might seem sensible if taken at face value, but there is a lot of research to suggest that the approach is flawed.
“There are only two types of people when it comes to market timing: (1) People who cannot do it, (2) People who have not realized that they cannot do it.”
Trying to predict how stock markets will move in the short term is arguably impossible because any short-term movement in the markets is due to a number of factors, one of which is human psychology. ‘Panic selling’ during a downturn tends to drive markets even lower temporarily, as the more investors there are trying to sell their stocks and shares (thus increasing supply and decreasing demand), the less these investments appear to be worth.
Let’s consider that there have been six major stock market crashes in the past 35 years :
1987 Black Monday – the Dow Jones Index fell by 22% in one day.
1997 Asian Economic Crisis – stock market crashes occur in Hong Kong, Thailand, Indonesia, South Korea and across the region.
1997 Russian Economic Crisis – Russian Government devalues the Ruble, defaults on domestic debt and declares a moratorium on paying foreign debt.
Tech Stocks Crash – Amazon shares fell by 96% from the previous high in 1999 (they seem to have bounced back since).
2008 Global Financial Crisis – worst global stock market crisis since 1929. Lead to a number of bank failures in America and Europe (Lehman Bros. probably the most well-known) and stock markets around the world tumbling. If you held investments in 2008 you could have seen their value fall by as much as 40%.
2020 Coronavirus Crash – the most recent stock market crash. During the week of February 24th the Dow Jones and S&P 500 fell by 11% and 12%, the biggest weeks fall since the financial crisis of 2008. Both indices had rebounded back to their pre-pandemic peek by the end of 2020.
All of the above were alarming at the time and will likely have evoked the same urge in investors to sell before things got worse; however, as markets stabilise and investors calm down, investments begin to recover. In this way, we find that many of the stock market’s best days immediately follow their worst.
Let’s put timing the market to the test though: let’s say that you invested £1,000 in the FTSE 250 (a UK market index of the top 250 companies) in 1986. Over the course of the next 35 years you proceed to time the markets, buying and selling at points that you considered appropriate. No one’s perfect though, so let’s assume that you missed some of the index’s ‘best days’:
- – If your investment missed 10 of these then at the end of the 35 years your investment
- would be worth £24,156.
- – If you missed 20, your investment would be worth £15,487.
- – If you missed 30 of the market’s best days, your £1,000 investment in 1986 would
- be worth just £4,264 .
But what if you had just invested your £1,000 and walked away? 35 years later, your investment would be worth £43,592. In other words, time in the market worked better than timing the market.
If we widen our scope beyond these stock market crashes, since 2009 there have been countless times when you could have considered selling investments:
The thing you will likely notice first of all in the above graph is that, despite world events, the markets eventually kept going up. Quantitative Analysis of Investor Behaviour, a report produced by Boston research firm Dalbar, shows that an investor who remained fully invested in the S&P 500 Index (500 leading US publicly traded companies) between 1995 and 2014 (again a period where five of the major stock market crashes occurred) would have earned an annualised return of 9.85%. If the same investor had missed just 10 of the best days, the annualised return would have reduced to 5.1%. Effectively, that investor’s return would have almost halved by being out of this market for that short a period, and the point of these figures is to show that trying to time the market can seriously damage your wealth.
Every story should have a moral, and the moral of this story is:
Time in the market beats timing the market anytime!
As with anything in financial planning, however, what the right decision will be for you will be dependent on a myriad of factors, including your personal circumstances and objectives. We would therefore strongly recommend seeking independent financial advice from a professional before making any decisions.
Roy Ritchie DipPFS
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Information is based on our current understand of taxation, legislation, and regulations. Any levels and bases of, and reliefs from, taxation are subject to change.
The scenarios included are for information purposes/general guidance only and should not be interpreted as advised recommendations.
The value of investments and income from them may go down. You may not get back the original amount invested.
Past performance is not a reliable indicator of future performance.
Schroders. Refinitiv data correct as at 19 May 2021