By: BILL BLEVINS
financial@portugalresident.com
THE TRADITIONAL maxim for stock market investment is “buy low, sell high”. While this sounds sensible advice, it’s much harder than it sounds. How do you know that a share price won’t fall further? And how do you know when a share price has peaked? Could it continue climbing?
Unfortunately there is no formula which tells investors when a share price has hit its lowest or highest. If there was, there would be many more stock market made millionaires. Even professionals with specific training and years of experience cannot predict what is going to happen with accuracy.
The media image of stock market investment can be rather dramatic (lots of shouting into phones on the trading floor) but in truth, possibly the key attribute you need to make money from stocks and shares is patience. Unless you are happy to gamble with your money, it is patience that you need in order to safely make money from the stock market, and by patience I mean a long-term time horizon.
High risk strategy
There is ample evidence from a range of dependable sources that show that it is time in the markets, not timing, that works to achieve the best results from your investments. Speculating rather than investing is a high risk strategy, especially if you are retired or have limited capital.
Instead, you need to give your investments time in the markets, so that over a number of years your investment capital can grow and overcome any temporary volatility.
Stock markets do fluctuate. They have periods when they are doing well and periods when they are not. Much depends on outside influences such as global politics, terrorism activities, major disasters, consumer demand etc. People cannot accurately see into the future and know what is going to happen and movement on the stock markets often take people by surprise.
The key to successful stockmarket investing is not to anticipate what is going to happen, but to remain invested for a period of time, at least five years, but often 10 or more so that you are positioned to benefit from all the upswings that happen.
One mistake investors often make is to wait too long before investing. They may be waiting for a share price to fall further before they buy it, or waiting until a period of volatility has passed before putting their money in the stock market. However, since they cannot accurately predict when share prices will rise, and they may shoot up over one day, it’s very easy to miss out on some or all of the gains.
Another mistake is to jump ship at the wrong time. Often, in fact, you should not jump ship at all and instead patiently wait for the markets to recover. Selling the shares just after they have fallen means there is no opportunity to recoup the losses when the shares inevitably rise again.
2Much research has been carried out on investor behaviour. Dalbar Inc researches measurements of success and say that investors abandon their financial plans at the worst possible times during down markets whereas systematic investment shows the value of staying the course.
After studying investor returns over a 20-year period it concludes that “investment return is far more dependent on investor behaviour than on fund performance. Mutual fund investors who hold their investments are more successful than those that time the markets”. This is regardless of whether the markets were going through good times or bad.
Over the 20-year period to 2005, the S&P 500 rose 11.9 per cent (cumulative annual growth rate), however the average US equity investor only made 3.9 per cent (cumulative annual growth rate) because they did not “buy and hold”. They tried to time the market or sold at the wrong time.
Dalbar illustrates its point with the story of Quincy and Caroline, a couple who each invested 10,000 US dollars into the same mutual fund at the beginning of January 1986. Quincy kept a close eye on this investment. When the markets took a tumble he worried about losing money and withdrew some of the investment. Once the markets had recovered and he felt more confident he would invest it again. He read newspaper stock reports and listened to advice from friends. At the end of 2005 Quincy’s original 10,000 US dollars was worth 21,422 US dollars.
Caroline, on the other hand, had not touched her investment at all. She left it invested in the same fund throughout, whether the markets were going up or down. At the end of 2005 her 10,000 US dollars was worth 94,555 US dollars!
Over a market cycle equity gains tend to be made within a few key days a year and it is easy to misjudge and miss those days.
Best results
Dalbar’s example is based on one US equity fund, but we see similar scenarios this side of the Atlantic. Consider this example reported in the Daily Telegraph: “If you had invested 1,000 pounds sterling in the FTSE All Share index on December 31 1991 and stayed fully invested in the market until December 29 2006, your investment would have been worth 4,506 pounds sterling. However, if you had missed the best 40 days (just three or four days a year) by not being fully invested the whole time, your investment would have been worth only 1,233 pounds sterling”.
Along with a sensible, balanced portfolio, it’s time in the market that achieves the best results.
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