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Investment Strategy
Monday, December 1, 2008
Can you really time the markets?

It is tempting to try and time the stock market. Some investors believe it is possible to enter the market before an upturn and disinvest before a downturn, thereby crystallising large gains. “But,” says Anil Jugmohan, Investment Analyst, Nedgroup Investments, “more often than not, they are likely to fail in their attempts.”
If one considers the global market volatility that we are currently experiencing, many investors are now being swayed by their emotions to try to time the markets. “There are many ways to attempt to do this,” he says. “In some cases, the decision is as simple as moving into cash for a while until the volatility subsides, while others may wish to actively time the markets by moving in and out as necessary. We have considered the effectiveness of both these approaches in our research.”
The first graph shows how your funds would have grown if you had invested R100 in the equity market in January 1980. The green line assumes that the investor pursues a ‘buy and hold’ strategy over the period, which means that you do not disinvest regardless of how much the market is falling. The gold lines show how your funds would grow after disinvesting from the market at various times after a 20% drop and then moving completely into cash. Note that since 1925, there have been 12 instances where the market has fallen by more than 20%. It is assumed that cash is taxed at a marginal rate of 30%, while CGT and costs are ignored.
Comments Jugmohan , “It is worthwhile noting that if the investor sells out of the market he would often be worse off than if he had stayed invested. Although markets may fall even further, and though it may take time for the equity market to beat the returns achieved from being in cash, it can be seen from this graph that the market does eventually provide returns, which are superior. When the investor buys into the market again at some point in the future, he will probably have to pay higher prices.”
The red arrow highlights the effect of the current market downturn on fund values. “Of course, we don’t know when the market will turn around or if it will fall even more from its current levels, but we can say that long term investors should not be fazed by the drop, and that they probably should not disinvest now. In fact, some of the best returns have been achieved by investing after a crash.”
Even disinvesting from the market for very short periods of time can be detrimental to achieving good returns, he points out. The next graph shows by how much your return can fall if you miss out on some of the best days of the market.
The orange bars show the returns that an investor would have achieved and is measured on the left vertical axis, while the green line shows by how much an investor’s overall return would fall, and is measured on the right vertical axis.
For the ten years to 30th September 2008, those who remained fully invested in the South African equity market would have achieved a return of 432%. “If you missed the best 10 days,” notes Jugmohan, “your return drops by almost half to 220%, and if you missed the best 30 days your return would have fallen to a meagre 56% over the entire 10-year period (which is less than 15% of the return that you would have got if you just remained invested in the market). It is amazing how quickly investors can diminish their achievable returns just by missing a few days in the market.”
The second aspect of our work included a back-tested study, which considered whether investors can beat the market by switching between equities and cash. “We tested a variety of market timing strategies that investors might consider using, and found that it is extremely difficult for any of these strategies consistently to outperform a simple buy and hold position,” he says.


Using 40 years of data until 30th September 2008, it was found that more than 85% of investors achieved worse returns than a simple buy and hold strategy, while almost 10% of them achieved returns even lower than cash (but with volatility similar to equities). Furthermore, if one factors in the cost of switching between equities and cash each time (as well as the effect of tax), the potential outperformance becomes even less likely.
Equities are an important asset class for long-term wealth creation, so any portfolio aiming for growth should have an equity component. This decision can only be made, however, after carefully considering your needs and circumstances with an expert, as well as considering your ability to bear any losses. It is important that one understands the risks of making such investments, and investors should not be fully invested in equities unless they are willing to maintain their position for at least seven years.

Copyright © Insurance Times and Investments® Vol:21.11 1st December, 2008
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