You might have heard someone boast about how they bought shares in a startup moments before its share price rocketed, or how they sold stocks just in time to avoid a loss.
Indeed, some investors who bought shares in the US retailer GameStop at just the right time made a huge profit, while others who jumped on the bandwagon too late suffered serious losses. You can read more about this and other investment bubbles in this interesting article.
Hearing such stories, it may be tempting to think that building a strong investment portfolio is all about timing the market – buying and selling at the perfect moment.
However, one of the world’s most successful investors, Warren Buffett, once said: “The only value of stock forecasters is to make fortune-tellers look good.”
In other words, nobody can exactly predict a stock’s future value. Buffett’s decades of experience taught him that “time in the market” consistently beats “timing the market”.
Read on to discover four compelling reasons why a long-term investment approach could be a more effective way of building your wealth than trying to predict short-term market movements.
1. Timing the market could lead to missed opportunities
Unfortunately, no one can see into the future. The markets are unpredictable and second-guessing them is generally a futile exercise. Even experienced fund managers don’t get it right all the time!
Trying to time the market often focuses on avoiding the market’s bad days – although this means you could miss out on the good days too.
This is because the best and worst trading days often cluster together.
The chart below, recently published by Vanguard, shows the 20 best (orange bars) and worst (cyan bars) trading days since 1 January 1980.
Source: Vanguard
Frequently the best and worst days occurred extremely close together – where the cyan and yellow bars look like mirror images of one another. So, if you rush to sell your shares after a sharp downturn, your investments don’t have an opportunity to bounce back.
This demonstrates why timing the market accurately is so difficult and why it often results in missed opportunities that could hamper your overall returns.
Indeed, research by Visual Capitalist highlights the potential cost of missing the best days in the market compared to staying invested long term.
The below graph shows how $10,000 invested in the S&P 500 index between January 2003 and December 2022 would have performed if you’d missed out on the best market days.
Source: Visual Capitalist
If you’d stuck to a long-term investment plan for that 20-year period, you could have enjoyed returns of $64,844. In contrast, missing just 10 of the best days would have diminished your returns by $35,136.
2. Frequently buying and selling can be costly
There are various trading costs associated with buying and selling. So, trying to time the market and frequently trading could become expensive.
Trading costs vary but these might include:
- Your broker’s commission
- Stamp Duty charges on any UK shares you buy
- Foreign Exchange charges if you buy or sell investments that are traded in a foreign currency
- Capital Gains Tax on any profits you make from selling that exceed the Annual Exempt Amount.
What’s more, there’s always a difference between the buy (offer) and sell (bid) price for stocks and shares. This is known as the “spread”. The price to buy an asset is usually slightly higher than the underlying market, while the price to sell will normally be slightly below it.
The associated costs for each trade may seem relatively low, but these could add up over time and eat into your returns if you buy and sell often.
3. Timing the market could lead to emotion-based decisions
Focusing on short-term fluctuations and trying to time when you buy and sell shares could be an emotional rollercoaster.
As discussed above, the best and worst days in the market often fall extremely close together, so trying to accurately time these changes could be stressful.
You might find it hard to think objectively about your investments and you could be at a higher risk of basing your decisions on your emotions instead of careful analysis of the data.
Indeed, market timing often leads to jumping out too early or staying too long.
This may be due in part to what author Carl Richards describes as the “behaviour gap”. It feels instinctively “right” to sell stocks when everyone around you is nervous and buy when everyone feels optimistic. However, these are emotional, not rational decisions.
4. Long-term investments may benefit from compound returns
Remaining invested for the long term could give your money more time to potentially grow, thanks to the powerful effect of compound returns.
In simple terms, compounding means earning returns on both your original investment and on returns you received previously.
Just as a snowball rolling downhill will gradually gather more and more snow, growing bigger and heavier over time, compounding returns can help even modest investments grow.
Most importantly, the longer you hold on to your investments, the more time your money has to benefit from the cumulative snowball effect.
The table below shows how compound returns could grow an investment of £10,000 over 20 years, assuming annual growth of 2%.
Source: Barclays
As you can see, compounding can help to grow your wealth over time. While the returns over 20 years may not seem dramatic, this example includes a single investment of £10,000.
The more you invest, the higher the return, and the longer you keep your money invested, the more powerful the effect of compounding could be.
On the other hand, trying to time the market could lead you to sell shares in response to short-term market fluctuations. As a result, you could miss out on the benefits of compounding.
So, focusing on time in the market rather than timing the market could help you grow the value of your investment portfolio long term.
Get in touch
Working with a financial planner can help you avoid common investing mistakes such as trying to time the market. We can help you create a robust investment strategy that aligns with your long-term financial goals.
To find out more, please get in touch. Email hello@sovereign-ifa.co.uk or call us on 01454 416653.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
