It is natural, in times of crisis, to feel the urge to take action. One of the most peculiar things about this most peculiar time is that the best thing any of us can do to stop the spread of the novel coronavirus is to do nothing, and this directive flies in the face of human nature. We may feel the same impetus when it comes to our portfolios, either to sell things that are going down to stop the psychic pain that accompanies losses, or, conversely, to want to back up the truck to take advantage of market dislocations. Anticipating future market moves is difficult in the best of times; it is impossible at present and can be hazardous to your wealth.
Market returns are not normally distributed – they are concentrated in a small handful of trading sessions, and missing out on those few days makes all the difference between successful and unsuccessful investing. The nearby graph illustrates the growth of a hypothetical dollar invested in the S&P 500 index on January 1, 1988. Through last Friday (March 20), one dollar would have compounded to $18.35 even with the 30% drop in the index over the past month.
A little more than half of this return takes place in just 10 days. Missing those 10 days (out of over 8,000 trading sessions) would have left you with a return of $8.78 over the same period. To make matters worse, the best days in market history often occur in close proximity to the worst days. Volatility is a two-way street, and it comes in clusters. The bar graph illustrates the 10 best trading days since 1988, along with the market returns for the day before and the day after. Notice the recent example of the 6.0% market rally on March 16, 2020. This healthy return was preceded by a 12.0% drop in the previous session and then followed by a 5.2% drop the next day. Timing this sort of volatility is impossible.
As a final illustration of the futility of market timing and the importance of disciplined and patient compounding, consider two hypothetical examples of egregiously bad or unlucky market timing. March 24, 2000 was the peak of the dot-com bubble, and, in retrospect, a really bad day to put money to work in the stock market. An investor on that day would have lost half her money in short order (as measured by the S&P 500 index), only to recover and then lose half again during the Global Financial Crisis. Nevertheless, this dollar invested on the worst imaginable day would have compounded to $2.23 as of last Friday (March 20).
Similarly, a dollar invested on the day before Lehman Brothers filed for bankruptcy in September 2008 would have declined by close to 50% before rallying to end last Friday at $2.35. The road to investment success is anything but a straight line.
Timing the market is impossible, and trying to do so can easily come at a steep price, as this quick survey of historical experience indicates. It is not easy to be patient, particularly when so many of us are working from home while balancing the competing demands of family and business and watching market volatility and policy responses unfold in real time.
In the 1930s, New York Mayor Fiorello LaGuardia named the twin stone lions guarding the steps of the main branch of the New York Public Library Patience and Fortitude for the qualities he believed that citizens needed in order to persevere in difficult economic times. The same qualities apply to portfolio preservation as well.
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