PETER DOLEZAL: The consequences of timing the markets

An investor’s motivation for selling their holdings can sometimes be attributed to fear.

Despite compelling evidence on the folly of attempting to time financial markets — equity or fixed income — many investors still cannot resist the urge to try periodic moves in and out of various investment products.

A recent Dalbar Inc. study, Quantitative Analysis of Investor Behavior — 2014, delivered perhaps the most startling proof of the price investors pay when making investment changes based on personal predictions of market moves.

This study looked at investors’ actual returns relative to the 20-year annualized returns to December 31, 2013, of both the S&P 500 (equities), and the Barclays Aggregate Bond Index (fixed income).

Annualized returns of Equity investors during this period averaged 5.0%, whereas the S&P had averaged 9.2%.

In fixed income, investors’ returns averaged 0.7% annually, compared to 5.7% delivered by the Bond Index.

What this extensive survey shows is that had the typical investor, rather than moving in and out of investments, remained invested in his/her equity and fixed income portfolios over the entire 20 years, annual equity returns would have been some 84% higher, and fixed income returns some eight times higher.

Sometimes, an investor’s motivation for selling holdings is not an effort to time the market, but rather fear.

When a significant market sell-off begins and markets adjust downward, some investors bail out, rather than watch their portfolio value decline on paper. The difficulty of course, is knowing when to buy back in. Many end up buying back into the market at higher levels than when they sold — thus assuring themselves of an actual net loss on the two transactions.

Over the past 60 years, North American markets have experienced a dozen major negative corrections (Bear Markets), with an average decline of 26% and an average duration of nine months. On the other hand, the major positive (Bull) markets have delivered an average total gain of 120% and have lasted, on average, 44 months.

Even more telling is that in the same 60 years, the worst S&P/TSX Composite Index performance in any five-year period of was a loss of only 1.9%. Over their worst five-year period, U.S. market losses were comparable.

This compelling evidence emphasizes that by staying the course, and riding out the inevitable shorter-term market corrections, an investment portfolio should be worth far more in the long term.

Investors must realize that they do not incur a real  loss just because markets adjust downward. However, if they do sell in a downward market, they may well crystallize an actual loss, which will in turn affect their long-term returns.

The key to remaining calm during a market downturn is to already be comfortable with the caliber of one’s investments. Portfolios should be well-structured in low-cost, solid-yield, well-diversified holdings, both in terms of asset class, sector, and geographically. With a solid foundation, waiting out occasional market corrections will almost always prove to be the smartest long-term strategy.

A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his recent Second Edition of The Smat Canadian Wealth-Builder.