Wise Wealth Advisors

D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Trying to Time the Market is a Fool’s game: Do you want to be one?

Posted by Muthu on July 25, 2010

I’m amazed as to how many novices including CFPs, Investment Advisors, Stock Brokers, Wealth Managers and Investors think that they are good in timing the market. These people believe that they could time the market to perfection. However, genuine expert after expert has gone on to say that trying to time the market is a fool’s game and should be avoided at all costs.

As Personal Finance legend John Bogle points out, the way to wealth for the stock brokers is to persuade their clients and say ‘Don’t just stand there. Do Something’.

But the way to wealth for the clients is the opposite maxim ‘Don’t do something. Just stand there.’ This is the only way to avoid playing a loser’s game.

It is impossible to predict the best and worst days in the stock market.

For example, over the last 10 years, the worst single day was 17th May 2004, when the market dropped 11.14%. However, exiting on that day would mean losing out on a gain of 8.25% the very next day! This rise was indeed very rapid, but what’s more important, is that the climb was almost as high as the best single day of the decade – 1st March 1999, when the Sensex gained 8.97%.

Missing just few days of good performance can significantly reduce your over all returns.

Let us take a ten year period – 30th June 2000 to 30th June 2010.

Remember this ten year period contains the most spectacular rise and fall of the Stock Markets.

Let us assume you’ve invested in Sensex during the above 10 year period. Ofcourse good diversified equity funds have provided far superior returns than Sensex. We’ll come to it little later.

During the last ten year period, if an investor would have missed out the ten best days in the stock market, a sum of Rs. 100,000 would have returned a paltry Rs. 1,74,964 as opposed to Rs. 3,72,747 had he stayed fully invested.

Your investment of Rs.100,000/- invested ten years before in Sensex is worth following

Remain Invested – Rs.3,72,747
Missed best 10 days – Rs.1,74,964
Missed best 20 days- Rs.1,02,894
Missed best 30 days- Rs.64,860
Missed best 40 days – Rs.43,474

The cost of missing best 10 days is Rs.1,97,783 where as cost of missing best 40 days is Rs.3,29,273.

Infact your capital would have got significantly eroded if you’ve missed the best 30 and 40 days.

For missing, just best 20 days, you would not have even received even Savings Bank interest.

Tell me honestly, in hindsight, how many of us would have been able to predict the best 10 days during the last 10 years leave alone predicting the best 40 days?

But the whole stock broking business (where you get daily tips!) is run on their ability to time the market. They are the fools of the  market and people (customers) who believe in them are the bigger fools of the market. Atleast the fools of the market earn income at the cost of bigger fools. Where as the bigger fools end up loosing every thing. So the fools are actually intelligent and the bigger fools are only dumb and ultimate losers. This is applicable not only to stock trading but also trading in derivatives, currencies, commodities etc.

Before you venture into trading of any form, ask yourself the question, ‘Do I want to be the Bigger Fool of the Market?’

In stock markets, money always moves from the pockets of most active to the most patient.

Let us listen of Dhirendera Kumar of Valueresearch:

“Anyone can invest regularly when the going is good, but can you stay the course and continue to invest when the going gets bad? The way stock markets behave, it isn’t easy to figure out what’s likely to happen in the short or medium term. Is it possible to have an investment strategy that will make money in the long-term regardless of what happens in the short-term? If the past is anything to go by, then there certainly is.

The fact is that all the nerve-rattling action of the rise and fall of the Sensex has nothing to do with the small investor and should not bother you. If this sounds bizarre, here’s proof from time. We studied the SIP (systematic investment plan) returns of diversified equity funds over the last 10 years. How much could you earn by this simple way of investing and going at it for a long time? You’ll be surprised.

If you had invested Rs 20,000 a month for the last ten years in any one of the better mutual funds, your Rs 24 lakhs could have grown to almost a crore of rupees. In fact, the best few could have left you with a stash that would be substantially more than a crore!

And mind you, the last ten years were not exactly a trouble-free period. There would have been times when your portfolio would have come under a serious threat of going into the red. And what could you do then? You could either exit the market to save your capital. Or be patient and go on to become a crorepati!

The key we are pointing out to is ‘long-term’ investing. Instead of figuring out where the stock market will be next week or next month or next year, just focus on the simple strategy of investing a steady amount regularly and keep doing it month after month, year after year.

The all-important role of time can also be demonstrated with another example. Consider two investors A and B who set out on their journey to accumulate wealth. Investor A realised the potential of equities quite early and started investing Rs 20,000 a month, 10 years ago. Investor B, on the other hand, procrastinated for five years before finally buying into the equity story. He started investing double the amount each month to catch up with his friend. Despite investing an equal amount of Rs 24 lakhs, Investor A would be almost twice as wealthy as Investor B as his money would have more time to compound.

The lesson is simple – there is no substitute for time so the sooner you start investing, the faster you will join the elite club of crorepatis. A story about building wealth over the long term could have concluded here, but stepping back in time reveals some more compelling facts.

We decided to move away from the glory of the last few bull years to check results over different time periods. Since mutual funds have not been around that long, we used the Sensex to check out SIP returns for every block of ten years since 1980.

What we found is that while an investor would have earned far higher returns than other asset classes in most of the decades, equities did show their fearful face in two of these 10-year periods – those ending in 2001 and 2002. In fact, the performance had been uninspiring in the decade ending 2000 as well, when the markets failed to earn a return equal to the risk-free rate. The caveat ‘mutual fund investments are subject to market risks’ does deserve some attention after all. But there are a lot more things to consider before jumping to a conclusion.

First, the superb returns generated even by passive investing for so many years. It was only in two out of 18 periods under consideration that the markets threw up a bad surprise. Further, the fact that these two decades ended during the worst meltdown till then, will have to be discounted as extending your investment horizon by a couple of years could have turned things around quite dramatically. And lastly, this analysis was based on passive investing. In actuality, actively managed funds have beaten the market by a huge margin.

All this leaves us pretty convinced that over the long term even small investors can become wealthy. So while you keep trying your luck at some of the popular game shows, keep investing small amounts in mutual funds as well. The probability of becoming a crorepati through the latter is much higher.”

(With inputs from Dhirendra Kumar and Sensex performance data from www.fidelity.co.in )

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