Doing This Can Destroy Your Returns
You may have heard advice or read articles about the opportunity cost when you miss the best days in the market. But just how much does a couple of percentage points affect the value of your investments over the long term?
In the table above, you can see how an investor who missed the best days in the market does not come close to the investor who stayed in throughout market ups and downs.
Imagine two people invested $10,000 in 1928 into the market with the longest dataset available (represented by the S&P 500). The only difference between these 2 individuals is that while one person stayed throughout the investing journey, the other one missed the 50 best days of returns in the market.
So how does someone end up missing the best 50 days of returns? It’s not as dramatic as you might imagine — it can happen from the simple act of shifting investments from equities to cash (or other perceived safe instruments) during times of perceivable market turmoil. We have written articles before showing that both the best and worst days in the market occur during periods of high volatility.
It is logical to instinctively want to try and save your capital when things are uncertain and you are experiencing big losses. But as you can see, that may have severe repercussions. The buy-and-hold investor ends up with $71 million; this is compared to the $1.6 million for the investor who missed the best 50 days. Missing the best days in the market can invariably impair the growth of your wealth.
Of note, when we look at exactly which 50 days that yielded the highest returns for the past three decades (since 1992), 25 of those days took place during a bear market (that’s an astounding 50%); a further 28% of them occurred within two months of a new bull market¹, shortly after the rebound. That’s a total of 39 days out of 50 that occurred within a relatively short period of time of high market volatility.
Investors panicking and selling during a bear market and waiting for a recovery before going back in would potentially mean missing out, resulting in an incredibly significant opportunity cost.
Because we really cannot predict when the worst and best days of the market will happen — our advice to all investors is to familiarise yourself and get comfortable with the idea of cycles, how losses occur, and to really construct a robust investment plan that focuses on the long-term goal, ensuring that the possible losses you face will be within the boundaries of your comfort zone.
It is of paramount importance to stay seated during market declines because:
No one knows where the bottom of the market is.
Related to point 1, there has been no robust evidence or strategy that allows for the consistent and accurate timing for the bottom of the market.
There is a large probability of capturing important recovery gains during a correction.
78% of the best returns² happened during the toughest times of the markets.
The caveat here is that you must be holding a market portfolio to capture these returns as this might not apply to esoteric strategies such as hedge funds or a concentrated portfolio of stocks. While the example above is for the USA market, you can further diversify your portfolio by embracing a global portfolio.
As we step into the new year, you may be feeling uncertain,
maybe you’re not sure:
If your investments are positioned to capture the returns in 2023
If your investment plan is on track to hit your financial goals
How to diversify your portfolio
It is a good idea to do some housekeeping and tidy up your investments and financial plan as we enter the new year
In the same way that you would not attempt a high risk activity such as sky-diving without professional supervision, investors can benefit greatly by relying on an adviser — having the peace of mind knowing that their plan is in the hands of a professional.
If you would like to receive a complimentary second opinion on your financial plan, or just have some burning questions on your mind, click here to schedule a 30-minute session with us.
References
¹ Ned Davis Research, Morningstar, and Hartford Funds
² Ibid.