Time in the market or timing the market?
Many global equity markets are hitting all-time highs, and that’s raising fears that they may be overvalued. The question for any investor is whether to put your money in the stock market now or wait for a potential pullback and cheaper valuations. But when it comes to long-term investing, should you really worry about timing your investment to perfection?
Equity markets have performed extremely well over the past few years. The S&P 500 and FTSE 100 have climbed 2.2% and 2.3%, respectively, in 2017 so far after rising an impressive 33.6% and 19.1%, respectively, in 2016. A recent survey by Bank of America Merrill Lynch found that net 34% of fund managers now believe stocks are overvalued — the highest proportion of respondents in 17 years.
The forward price-to-earnings ratio - a way of valuing companies that can be used as a valuation metric for the market as a whole - can be used to gauge whether a stock index looks relatively expensive or not using forecast earnings for the next 12 months. The value for the FTSE 100 has fallen back since its peak of 17.5x in September 2016 but it still stands at 14.8x, higher than the 12.5x average since 2005.
Lofty valuations are one concern, but the rest of 2017 also carries a significant amount of political and policy risk for markets.
Although the market seems to have successfully navigated events this year, such as the inauguration of US President Donald Trump and UK Prime Minister Theresa May triggering Article 50, there are still a number of political speed bumps with the potential to disrupt the global economy. There are elections in the UK and Germany, rising tensions in the Korean peninsula, and expectations are building that the US Federal Reserve may step up the pace of US interest rate increases. China’s Communist Party will also hold its 19th National Congress at which President Xi Jinping is expected to consolidate power.
These headwinds will likely lead to a number of wary investors sitting on the sidelines, waiting for the next market drop in an attempt to perfectly time their investment.
However, it is very difficult to predict when this 'perfect' time to enter the stock market actually is.
One of the biggest risks of attempting to time the market is potentially missing out on the market's best-performing cycles. Even losing out on just one strongly performing day a year can have severe consequences on your returns over time. The chart below shows the impact on performance if an investor had missed out on the best performing day of each year over the last ten years.
If you had invested £10,000 in 2007 - inconveniently just before the financial crisis - and held your position through to now, your investment would now be worth over £17,300. Missing the best day of each year however would mean your investment would be currently valued at a far smaller £11,100.
This is why the best move for most individual investors - especially those targeting good, long-term growth - is to buy a diversified portfolio and hold onto it for the long term.
The buy-and-hold strategy also works because it forces you to ignore your emotions. It is human nature to hang onto losing investments for too long and sell winning positions too soon. Ben Graham, the father of value investing, famously remarked that 'the investor's chief problem - and even his worst enemy - is likely to be himself.'
According to research by Charles Schwab, between 1926 and 2011, a 20-year holding period in the S&P 500 never produced a negative return, highlighting the benefits of holding your portfolio for longer periods of time.
We have recreated this analysis for the FTSE 100 below. If you had held the FTSE 100 for any 20-year period since its inception in 1986, your minimum annualised return would have been +6%.
Clearly, then, time is more of a friend than an enemy when it comes to investing. Don’t try to time the market, but spend time in the market.