(F)Utility of Trying to Time the Market
Updated: May 31, 2020
If only we had a dollar for every time we had this conversation with a client…
Client: “Siddhanth, I want to invest 50 lakhs in equity. Should we do it now? Or should we wait for the market to correct a bit/improve a bit?”
Me: Honestly, trying to time the market is futile. There’s plenty of evidence to show market timing has very little long term relevance in wealth creation for a successful investor. Since this investment conforms to your recommended asset allocation and fits your objectives, we should just go ahead.
Client: “Yea yea but kya lagta hai market ka?”
This piece is an attempt of trying to evaluate the (f)utility of timing the market, to try and see if what we say to clients has any merit or are we just using the same “don’t try to time the market” pitch used by wealth managers across the world.
Before we get into the data and statistics, we would request that you take a second and ask yourself the following question, “Am I a trader or an investor?” Remember, a trader is someone who looks to make a frequent profit, for which volatility of the market is a blessing. An investor on the other hand implies a long term investment horizon. If your answer to the question is investor, we’ll go ahead and share the conclusion of this article first – Trying to time the market is not only impossible and futile, it can be severely detrimental to your portfolio in many cases.
The following analysis well supports what’s written above. We assume there are two investors – both of whom invest 1 lakh in Nifty every year beginning calendar year 2000 to 2019.
1. Mr. Logic invests in the beginning of every financial year i.e. 1st April irrespective of Nifty’s value. He doesn’t believe that it’s possible to time the market.
2. Mr. Lucky is an expert market timer and somehow is always able to invest at the lowest Nifty level in that calendar year.
So for example in the year 2000, if Mr. Logic bought Nifty at 1,528, Mr. Lucky bought it at 1,136. Similarly in 2019, Mr. Logic bought Nifty at 11,559 and Mr. Lucky bought it for 10,604.
By the end of 2019, each investor has put in 20 lakhs. The two investors compare their portfolios as on 31st December, 2019 and they find the following:
Mr. Logic has a portfolio value of 84.66 lakhs, with an XIRR of 12.61%.
Mr. Lucky has a portfolio value of 1.03 crores, with an XIRR of 14.51%.
Despite Mr. Lucky’s magical ability to time the market perfectly, it’s fair to say that he is not able to add significant value. His XIRR is 1.90% greater than Mr. Logic. While there is no denying that an annual 1.90% compounds to a significant value addition over time (18 lakhs in this case), it is needless to say that Mr. Lucky is only a hypothetical (rather aspirational) character. It would be wishful thinking on our part to think we can be this person and successfully navigate through the market’s volatility every time. It is fairly obvious that a bulk of the investor’s returns have come from disciplined investing and staying in the market rather than timing the point of entry.
In fact, we did the exact same analysis for Franklin India Bluechip Fund, a flagship large cap fund in existence since 1993 and found the same result. Mr. Logic had made a return of 16.58% whereas Mr. Lucky made a return of 18.39%, again a difference of 1.81%. The analysis carried out here on Nifty was replicated from a study done by Marcellus Investment Managers. However, they did it with Asian Paints. I’ve pasted a link down below if you are interested in reading about their results. https://marcellus.in/newsletter/consistent-compounders/quantifying-the-futility-of-timing-the-market/
Why does this happen? – In the long run, returns in equity are a reflection of the quality of the underlying instruments you’ve invested in. In this case, Nifty consists of the top 50 companies by market capitalization and the returns would be reflective of the long term earnings growth of these 50 companies. The point of entry therefore becomes insignificant.
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves I can’t recall ever once having seen the name of a market timer on Forbes annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it” – Peter Lynch, American investor, fund manager, and author. Peter Lynch is widely regarded as one of the most successful fund managers of all time averaging a annual return of 29.2% during his tenure at Fidelity Investments.
Another very interesting read we found that quantifies the potential damage to the portfolio by waiting on the sidelines for “when the market improves”. It studies the US Index S&P 500 and how missing out on just the top 20 trading days turns your positively handsome return to negative. In other words, if you were completely invested in the S&P 500 for 20 years but missed just the top 20 trading days, your time in the market is completely wasted. Here is a link of that article: https://www.fool.com/investing/2019/04/11/what-happens-when-you-miss-the-best-days-in-the-st.aspx
Siddhanth Jain | Partner