Markets can be intimidating beasts. They go up and they go down. Some people profit through their investments whilst others lose money.
How is an investor supposed to approach this picture? Should you put your money into markets given the risks involved? If so, how much should you commit and what should you invest it in?
Moreover, when should you put it in and when should you take it out? Should you withdraw your money as markets are falling or during periods of volatility to try and curb your losses?
This latter question is the one we want to focus on here. This is known as “timing the market” and, generally speaking, it is a bad idea.
It might seem counter-intuitive, but it is ultimately better to stay in the market for a long period of time rather than trying to time it. Here’s why:
If you are already investing, remember why you invested in the first place.
It might be because you wanted to build up enough money for a comfortable retirement one day. Markets can be a great way to achieve that. Consider, for instance, that equities in the UK have grown by 5% on average each year since 1900.
However, you likely knew that it wouldn’t be plain sailing when you first started investing. The very nature of markets is that they stop and start. They bring short-term risks but also the potential of longer-term growth.
Consistently predicting the short-term dips and troughs is incredibly difficult, if not impossible. Think about the number of variables involved leading up to a market crash or substantial rise. There are human decisions made within governments and companies, which themselves are very hard to anticipate. Then there are local and world events which come down to bear.
Trying to see the near-future in this ever-shifting puzzle (where new pieces are constantly thrown into the mix) is clearly beyond normal human capacity, although this does not stop lots of stockbrokers from trying!
It is very hard to see a market fall coming and pull your money out to protect it in time. In fact, trying to time the market in this way can really cost you both in the short and long term…
Consider for a moment what might happen if you missed some of the best days on the stock market because you pulled your money out at the wrong time.
One study actually tried to demonstrate this for the FTSE 250. It showed that if you invested £1,000 in 1987 and left it there for three decades it would be worth £24,686.
However, if during that time you put your money in and pulled it out, missing the FTSE 250’s best 30 days, then the money would be worth £6,878. That’s a difference of £17,808.
When you spread out the annual return over the thirty-year period, you would have seen an 11.3% return if you had kept your money in the FTSE 250.
Had you missed the best ten days it would be 9.3%. Had you missed twenty of them, it would be 7.9% and if you missed all thirty days it would be 6.6%.
These percentages might seem small, but over thirty years the difference amounts to a lot of money due to the nature of compound interest. There might be just 4.7% between 11.3% and 6.6%, for example, but remember that represents £17,808 in the above scenario.
In other words, rather than trying to time the markets it is almost always better to stay put and aim for long term growth.
The answer to that question depends on your own financial circumstances. At the time of writing, it might be tempting to think that you should not invest right now given uncertainties surrounding the U.S.-China trade war and Brexit.
However, this is not necessarily a reason not to invest. Historically, some of the best investment returns have happened during times of great economic challenge.
One sensible way to protect yourself from short-term market dips and shocks is through “pound cost averaging”. Very simply, this means that you put your money into the markets gradually rather than in one bulk.
So rather than putting £20,000 straight away into stocks (which might then suddenly go down), you could put £2,000 into stocks over a 10-month period, reducing your risk exposure. It might mean that you actually end up making a better return in the long run, because you could end up buying more stocks at a cheaper price during a market dip. If these then rise in value down the line then you actually will have gained a higher investment return because of the dip. Conversely, of course, you could lose out on gains if the markets continue to rise during your phasing period.
Unfortunately, you cannot completely shield yourself from short-term investment risks and market falls. However, there are some tactics you can use to increase your chances of gaining a higher investment return over the long-term: