2020 Is a Reminder Why Timing The Stock Market is Futile
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Of the many unprecedented things that 2020 will be remembered for, one is the stock market coming full circle in less than eight months.
Between February and March, the BSE Sensex nosedived from its peak of 41,945 by about 35 per cent driven by the outbreak of Covid-19 pandemic and its impact on the economy. Soon after in May, bulls were back in the driver seat and pushed the markets up by as much as 80 per cent over the next seven months. Sensex is currently trading at all time high levels of 47,000.
“This is probably the first time when both the bear and bull cycles occurred in the same year,” says Amit Jain, a Delhi-based financial planner.
The stock market roller-coaster this year has brought home the fundamentals of investing—stick to asset allocation and don’t time the market. Here are three reasons why timing the market is a futile exercise at best.
Timing the Market Can Prompt Emotional Investment Decisions
When the markets crashed in March, many stories surfaced where soon to be retirees or parents preparing to send their children abroad for higher studies lost a lot of money and were left short of the required corpus to fund their goals.
The question arises why didn’t they withdraw their investments if their goals were nearing?
“When the markets are attractive, as was the case in January, investors lose sight of their goals and stay invested out of greed to earn more,” explains Jain.
Similarly, investors who exited equities after the crash fearing the market will fall further lost the opportunity to recover their losses in the following months.
This is the peril of making investment decisions according to market movements.
“While timing the market, investors come up with many emotional and cognitive biases like loss-aversion, overconfidence, regret-aversion, self-control, confirmation, endowment and status-quo bias,” says Sharma.
No Meaningful Difference in Total Returns Over the Long-Term
The opposite of panic selling and buying out of fear of missing out is the ‘buy low, sell high’ approach. Unless you understand in great detail how the stock market works, experts advice against this as well.
“Deploying a lump sum just because the market has corrected is akin to getting admitted in a newly opened hospital because it if offering discounts,” says Rohit Shah, founder and CEO, Getting You Rich.
We applied this approach to the previous stock market cycles to understand whether investing additional sums every time the markets fall significantly results in better returns over the long term. Our back of the envelop calculations shows that it doesn’t.
Nitin Rao, CEO, InCred Wealth explains. “After the stock market hits the bottom, the actual gains are made in the rallies that occur only in the first two to three days of recovery. It is impossible to time this bottom as it happens very quickly before the investor can even get in.”
Divam Sharma, co-founder at Green Portfolio Services concurs. “It’s impossible for even the best of the stock market investors and analysts to predict the bottom and top of the markets.”
“Over the long-term investment horizon of 5-6 years, it doesn’t make a difference to your overall returns as those sweet spots of the rallies are generally missed by small investors,” Rao adds.
That said, mutual fund investors can definitely top-up their SIPs (systematic investment plans) in a falling market if their monthly budget allows it and they stick to asset allocation.
Following Market Movements Can Overshadow the Fundamentals
“Investing is a function of your risk, investment horizon and purpose of investment and not where the markets are headed,” points Jain. Basing investment decisions on the latter can not only astray the investor from his goals but also disturb his asset allocation, Jain adds.
It’s important that investors stick to asset allocation and not overdo equity in their portfolio if they don’t have the appetite for it. There is empirical data to show that disciplined equity investing pays off in the long-term.
“Investing consistently in a disciplined manner with a long-term investment mind-set is the best way to create wealth from stock markets. The power of averaging and compounding over 5-7 years deliver superior returns than trying to pick market bottoms and tops,” says Sharma.