Experienced traders would be familiar with the phrase “Timing the Market”, which basically means buying at the lowest price and selling at the highest. Of course, the execution of that phrase is far more complicated.
The truth is, far too few traders are able to consistently pick the right stocks that earns them an advantage over a “Time in the Market” strategy.
Here’s a simple illustration. Take a look at the performance of different indices over the past 14 years. Would you have been able to pick the best stocks for the best returns consistently over these 14 years?
If you were perfectly honest, you probably would not be able to do so, everytime. Markets are unpredictable, so it would be wise to spread your risk through diversification in a longer term investment strategy.
Why is this so?
In determining the correct time to buy a stock, you are in essence looking at historical prices. How can you be sure when a share has bottomed out? Similarly, how will you determine the price (or time) at which to sell?
Very often, investors who take this approach are left waiting on the sidelines. They watch the target company’s share price closely and try to figure out the best time to buy. If the price continues to rise, they regret their earlier decision to hold back, but make no attempt to make the purchase.
Conversely, when the price starts to fall, they often remain hesitant to make a commitment.
Does that sound familiar? If you have ever been in a similar predicament, this study by Peter Lynch may be of interest to you.
Timeless advice from Peter Lynch
Peter Lynch has a very impressive record as an investor and mutual fund manager. He managed the Magellan Fund at Fidelity Investments between 1977 and 1990. During this period, the fund averaged an annual return of 29.2%.
This was greater than twice the return provided by the S&P 500 in the same period. Peter Lynch’s investment skills resulted in the assets under management of the fund increasing from US$20 million to US$14 billion.
How did Peter Lynch achieve this remarkable feat? Was it by investing in stocks at exactly the right time and then selling them when their prices increased?
On the contrary, he held that the greatest returns were to be made by investing for the long-term. He said, “Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they’re going to be higher or lower in two to three years, you might as well flip a coin to decide.”
Peter Lynch says that:
- Holding investments for the long-term was the most effective strategy.
- The price at which you bought a share was not important. How long you held it was what mattered.
To prove his point, he conducted a study that analysed the returns provided by the market over a 30-year period from 1965 to 1995. He found that if an investor had invested US$1,000 a year on the date when the market was at its highest every year for a 30-year period, he would have made a compounded annual return of 10.6%.
What if the investor had made the purchases when the market was at its lowest point every year? The return would have been only a little higher at 11.7%.
When should you sell your stocks?
Warren Buffet is considered to be the world’s greatest investor. He is the CEO of Berkshire Hathaway, a financial services firm that has revenues in excess of US$240 billion. The company has a market capitalisation in excess of US$500 billion.
What is Warren Buffett’s view about the length of time that you should hold a stock? He says, “Our favorite holding period is forever.” If you are a long-term investor, you should resist the temptation to monitor the value of your portfolio on a minute-by-minute basis. Of course, that’s not to say that you should never sell a stock.
When Buffett bought IBM shares in 2011, he intended to hold them for the long-term. Instead, he sold a large chunk in the latter part of 2017. Why did he do that?
“I was wrong… IBM is a big strong company, but they’ve got big strong competitors too. I don’t value IBM the same way that I did six years ago when I started buying… I’ve revalued it somewhat downward,” he explains.
The importance of staying invested
If you buy a stock and its price rises rapidly, you may think it’s a good idea to sell and pocket the money. But unless you are a day trader or a short-term investor with the time, resources, and specialised skills for share trading, adopting this approach may not be the best strategy.
Peter Lynch bought shares in Subaru, a car manufacturer, after the company’s stock price had already risen 20-fold. Why did he do that? He was convinced that the company’s fundamentals justified a much higher price. He was right. After he made the purchase, prices rose seven-fold.
He explains the rationale behind buying a stock that has long-term potential. “Sure, some people bought Wal-Mart when it opened its 10th store, but others bought when it opened its 100th store. If a company has a good story to tell, that story will remain good for a long time.”
Today, the company has over 11,000 stores in 28 countries. Its share price has gained 50% in the last year alone.
Timing the market comes at a cost
Image source: Pixabay
One of the key aspects of timing the market involves making many transactions, buying and selling quickly to maximise the movements in the market.
However, one obvious downside from this, lies in the commission, administration and agent fees that you would incur from the transactions. In investment, it is essential to consider how your costs can erode your investment returns.
At the same time, it is common for traders to miss out on the best timing to enter and exit the market, given the rapid changes in the market. Missing out on those timings also means missing out on the best possible returns, or even making unwanted losses.
On the other hand, while an investor is waiting for the right time to enter the market, invested stocks being held for the long term will make more money than cash on the sidelines, and this reality goes beyond the individual investor.
Beyond the actual costs, there are also other opportunity costs from time spent monitoring and worrying about daily trades. Investors might also encounter buyer’s remorse, a cognitive dissonance arising from second guessing your trades.
Unpredictable markets are … Unpredictable
You may attend seminars and sign up for courses by investment coaches who are able to teach you how to identify the lows and the highs in the market, but even they will have their hits and misses in their investment.
While the benefits of staying invested for the long-term are many, investors often think that they can gain by selling a share and then buying it again when prices fall. However, that’s easier said than done because it’s very difficult to tell when the market has bottomed out.
Plus, if timing the market was truly that easy to grasp, everyone would already be doing it.
Disclaimer: The views expressed in this article are those of the author’s and does not necessarily reflect the views of their current employment/business. The information does not take into account the specific investment objectives, financial situation or particular needs of any person. Advice should be sought from a licensed financial adviser regarding the suitability of an investment product before making a commitment to purchase. Past performance is not necessarily indicative of future performance. Any prediction, projection, or forecast on the economy, securities markets or the economic trends of the markets is not necessarily indicative of future performance. Whilst we have taken all reasonable care to ensure that the information contained in this document is not untrue or misleading at the time of publication, we cannot guarantee its accuracy or completeness. The above report may contain data obtained from third parties and as such we cannot guarantee the accuracy of this data.