I’ve been hearing from several people who are selling out of shares as they are worried that shares will continue to drop. Their theory is that they will just buy back in once all this over. Sounds pretty simple right? Let’s see how such a plan may have worked out using the 2007/08 financial crises as an example.
For the data we will use the Dow Jones index. We will assume our investor had $100,000 invested one month before the crash and decided to sell it all on September 18, 2008, a couple of days after the Lehman Brothers bank collapse at an index price of 11,020. Their $100,000 was now worth $96,000. Great, just a 4% loss. By getting out at almost the best possible time (to the day)this has meant they didn’t incur a further 41% loss in the next 6 months.
Instead of having $96,000 they could have had $55,000. Good thing they left at the right time. They kept this $96,000 in cash. It wasn’t making money, but at least it wasn’t losing money. Over that 6 months they continued to save $1,000 a month. So by March 2009 they had $102,000.
What about the investor that wasn’t timing the market? How did they fare by continuing to stay invested and add $1,000 per month? They would have just $73,475. Almost $30,000 less than the market timer.
But there’s a problem. The market timer is still out of the market. When do they come back into the market? In March 2009, the index is only at 7,487. This investor sold when the index was at 11,020 and they thought the market was shaky then, so they sure wouldn’t buy back in now at the low. At this stage most people thought the market would continue to drop.
From March 2009 to August 2010 the market is rocky. It trends generally up, but the large ups and downs still concern the market timer. They decide to get back in in September 2010 as the increases in value become a bit steadier. The value of the index is now at 10,269. Less than what they sold for and they didn’t incur all those losses as the buy and hold investor.
By September 2010 the market timer now has $119,000 thanks to 17 months of saving $1,000 a month.
How is the buy and hold investor looking from being in the market during all these record falls? $111,000 with an assumption of 0.4% in investment fees.
Not a huge difference of $8,000. But isn’t it incredible that despite experiencing a fall of 45%, the buy and hold investor was only slightly worse off?
What if instead of investing $1,000 per month they were both investing $2,000 per month? The market timer would have $136,000 and the buy and hold investor would have $136,000.
And $3,000 per month? $153,000 for the market timer and $160,000 for the buy and hold investor.
Even though the market timer here was better off in many of the scenarios, don’t go thinking this is the best strategy. They got extremely lucky by selling out of the market after only a 4% drop when the market went down 45%. This is extremely fortuitous. Between the day they sold and September 2010 when they bought back in there were 14 better days to sell out of about 500 days. 2.8% of days were better than the day our market timer sold. And 97.2% of days were worse. This is extremely fortunate. If they sold at pretty much any of the 97% of worse days, they would have been worse off than the buy and hold investor.
What about the day they bought? Sure, the market timer could have bought back in at lower prices, but considering they sold at the very first sign of volatility, chances are they would have been far too scared to re enter the market any sooner than September 2010. Up until then the market was still volatile with significant ups and downs. Not until September, did volatility start to settle a bit. So really, this is the soonest they would have theoretically bought back in. It really is almost a best-case scenario for the market timer in terms of timing and the difference could have been so much worse.
For example, most people are OK with a 4% drop and wouldn’t have sold until at least a 20% drop.
Final thoughts
This is only one example, but it does show that you need to be extremely lucky to be better off as a market timer. You have to sell very early on in the drop off. Well before all the experts. This would have been extremely difficult in the current bear market which has seen the fastest drop in history.
The markets can move very quick so it can be too late. And they often give false drops, so it is very hard to know if it is the right time to sell. Is it a full recovery or only a blip?
But you also need to have the courage to buy back in at the right time too and more often than not, this is when everyone is selling, and people are worrying about the future of the economy. It’s much easier said than done. Not only do you have to have the courage, but you also need to have the luck to guess the right day. Markets can move so quick that a difference of just one day can make all the difference between getting it right and wrong
Trying to pick the time when this bear market will recover is extremely difficult. As of today, the markets could go down, up, or sideways. How do you know if last week’s recovery is a false positive or not? Chances are if you are the type of investor who sells at the first sign of losses, then you are also the same type of investor that will not buy back in until the market is less volatile. By then prices may already be too high. So to say you will just enter the market when it recovers is much harder to do than it is to say.
1/. How do you know it isn’t a false recovery?
2/. What if the recovery is so fast you miss out on the cheap price?
Most people will wait a bit to make sure it isn’t a false recovery before getting back in. Because if you buy back in on a false positive you can get badly burned. But by the time you know it isn’t false, so does everyone else. The decent buy in prices are gone.
What if a recession lasts for 3 years, instead of one and a half like the previous example? That is 3 years of being out of the market. Whereas the dollar cost average investor is continuing to buy at cheap prices. As long as you continue to invest every month, then buy and hold is as good a strategy as any. In fact, it is more often than not the best strategy. Obviously you have to be in it for the long haul though.
Anything in hindsight looks obvious. It’s not obvious at the time though. Who knew that whole countries would be in lockdown? Seems obvious now. Wasn’t some time ago.
You need to remember that the current price is the collective opinion of how everyone thinks the market will perform in the future. For every time you think is a good time to sell, someone else thinks it’s a good time to buy. It’s how markets work and all traders can’t be winners. Everyone’s a genius in hindsight and you can’t win if you aren’t even in the game.
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