I recently met with two of my clients, a retired couple, to review their investment accounts. They were pretty pleased with the performance so they asked me to take a look at an account they had managed elsewhere that hadn’t performed as well. After doing a bit of digging, it became apparent that a different strategy was being employed: market timing. This involves buying securities when you believe the market is about to go up and selling them when you believe the market is about to go down.
Market timing, technical analysis, program trading, whatever terminology is used to describe the process, is a method that rarely benefits an individual investor and often serves to generate higher commissions for the advisor. Anyone who has taken an introductory finance course will remember that missing the ten best trading days in any year can result in an investor missing a substantial portion of their potential return. This is so often quoted that it is treated as gospel by advisors. So I decided to look at returns for the S&P TSX over the three-year period ending December 31, 2011, the same time frame that my client had asked about.
Over the three year period, the stock market generated a positive return of 29.47%. $100 invested on January 1, 2009 would be worth $129.47 on December 31, 2011. If an investor missed the ten best trading days in each of the 3 years, 30 days in total, they would have lost 41.1%. So the saying is true.
However, when you look at the data, many of the worst performing days fall right around the best performing days. To be fair, a market timer probably isn’t only going to be out of the market on the 30 best days. If you had also missed the three days preceding and following the best performing days, you would have generated a positive return of 2.49% over the three year period. Much better than the loss of 41.1% but significantly lower than the buy and hold strategy.
It is only natural that as investors we seek to outperform the market. However, over the long term the best strategy is to diversify your portfolio across a large number of investment categories in a manner that reflects your tolerance for risk and your objectives for your portfolio. Properly structured, you will be able to withstand any market volatility and remain invested, resulting in superior long-term returns.