In a world where attention-grabbing headlines are the norm, it is easy to find excuses not to invest. This year has been no different, offering an endless array of news to test investors’ emotions and patience. Investors have had to assess how much weight to give to developments including a U.S. sovereign-debt downgrade and impending recession while keeping in mind positives such as cooling inflation and a resilient consumer.
As I highlight in Ten Basic Truths of Investing – 2.0 headlines often focus on the sensational, short term and negative – none of which should matter to long-term investors. There are always a variety of economic, financial and political events that will impact the performance of markets and lead to volatility over the short term. While it can be tempting to try and time the market over shorter periods, we know from experience how difficult that can be and the serious effect it can have on achieving long-term investment goals.
“The road to success is dotted with many tempting parking spaces.”
- Will Rogers
During periods of volatility, investors become fearful of potential losses and tend to reduce or eliminate their exposure to financial markets, thinking they will jump back in when the coast is clear. This often means they shift their portfolio weights through a higher-than-normal allocation to cash-like instruments. We have certainly witnessed this transition during the current cycle as the determination of central banks to rapidly raise interest rates from the zero bound have made cash a more interesting asset class and reduced the relative attractiveness of equities and bonds. In fact, during 2023, there has been a record movement of dollars out of stocks and fixed income and into cash, with money-market assets now exceeding $5 trillion (Exhibit 1).
Exhibit 1: Cash investments have increased significantly
Note: As of August 22, 2023. Source: Bloomberg, Investment Company Institute (ICI) All Money Market Funds Total Net Assets (U.S. Market)
While we acknowledge the appeal of sitting on the sidelines during periods of volatility, investors must carefully weigh the potential cost of inaction. How will you know that it is time to get back in and what is the impact on your investment returns while you are waiting? Avoiding the most severe down days in markets can no doubt benefit an investor, but missing even a few of the strongest days can also have a significant impact on your overall investment results.
In our view, achieving this perfect timing is a nearly unattainable undertaking. It involves making two decisions – when to get out and when to get back in. Even if you manage to pinpoint the right time to get out of the market, it’s highly unlikely that you’ll be able to get back in at the right time. It’s when headlines are at their most scary that your instincts will be telling you to steer clear. But history shows that the most frightening headlines offer the potential for the best future returns.
Although investors who stay out of the market during periods of volatility would succeed in avoiding the most unfavourable declines, they would also be missing out on some pretty sizeable returns. That’s because the best trading days tend to cluster around the worst ones (Exhibit 2). The conclusion to be drawn from this trend is that a significant portion of returns that contribute to robust long-term performance materialize during the initial phases of a recovery.
Exhibit 2: The best and worst days tend to happen close together
S&P 500 daily price returns (1986–2022)
Note: As of December 31, 2022. An investment cannot be made directly into an index. The graph does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results. Source: Bloomberg
Evaluating historical market data back to 1973 reveals that an investor who missed out on the 10 most profitable trading days in the stock market (of the more than 12,000 trading days that have occurred since then) would have generated about half of the return over the 50-year period compared with an investor who stayed invested (Exhibit 3). This year provides another good example: an investor who did not have exposure to the stock market during the 10 best trading days of 2023 would have had losses as of August month end versus the actual return for the S&P 500 of nearly 18%.
Exhibit 3: Value of $10,000 invested in the S&P 500
Note: As of August 31, 2023. An investment cannot be made directly into an index. The graph does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results. Source: Bloomberg
Staying invested is key
Adhering to a thoughtful and strategic approach to investing and staying focused on generating strong and consistent performance over the long term is the key to achieving investing success. Remember that financial market downturns have happened before and will happen again, but also know that financial markets have always recovered and trended higher over the long term. While it is natural to feel apprehensive during periods of volatility and want to do something to avoid the pain, consider the possibility that acting out of fear could result in your missing out on some pretty significant returns. As I have said before and will continue to remind people…it’s time in the market, not timing the market, that is the key to investment success.