We continue our series of articles about how investors can improve on the performance of their portfolios. Most investors understandably worry quite a lot about their investments. But in many cases these worries turn out to be counterproductive. Many people often focus their attention on a few positions in their portfolios, selling positions that have not performed well in the short term, and in the process crystallizing losses. When those same stocks bounce back, investors are often too late to get back in and miss out on the opportunity of participating when those positions return to growth.
This kind of behavior is often referred to as “timing the market”. This approach has proven many times in the past to be very difficult to get right. Often it is better to find a quality stock and hold it for the longer term. The results are often better in those cases, because respectable returns in equities generally are driven more often by the length of time holding the position, or ‘time in the market’, rather than trying to trade in and out of a position, or ‘timing the market’. It is extremely difficult for investors to predict when individual stocks or even stock indices will rise or fall, and often the investor will set a predetermined expectation of return that is extremely difficult to achieve. It also requires diligent monitoring of the position, and often the most opportune times to get out (or in) are missed because one is never 100% certain that a bottom (or top) in the position is reached. Even professional investors have a difficult time with ‘timing’ on individual positions, as can be seen by the poor performance of many hedge funds in the U.S. in 2015.
Chart 1 below shows that if you had missed the ten best days of the market over 20 years between 1993 and 2013, your annualized return would be almost 4 percentage points lower than the market’s return over that period (5.49% vs. 9.22%). And it is very easy to miss ten good days of the market over 20 years for most investors. In fact, it is quite easy to miss the 60 best days of the market over a 20 years time span while engaging in market timing. In this case, your annualized return would be -4.39%, instead of +9.22%.
At the same time, many investors could ask, what is the best time horizon for a buy-and-hold strategy? Time horizon requirements differ for different investors, depending on their age as well as other factors. Over the past 15 years, major stock markets have suffered several setbacks and it always took them some time to rebound and grow beyond the previous highs. For example, after the dot-com bubble burst, it took the Dow Jones Industrial Average index 5.5 years to regain its lost territory. During the last financial crisis, it took the index 4.5 years in 2007-2012 to grow to its previous high. During these periods, if investors grow impatient and lose hope, they often miss the opportunity for full returns.
Chart 2 shows that the longer one remains invested, the better the outcome. According to research conducted by Charles Schwab Company in 2012 (via Investopedia.com), between 1926 and 2011, a 20-year holding period never produced a negative result. According to these data, hanging on to the stocks for at least ten years would produce positive results most of the time. But in the cases of shorter periods, the odds of running into negative returns are much higher. In the case of 1-year periods, the chances of negative returns are almost as great as the chances are to make positive returns.
A buy-and-hold strategy is also called a passive investment strategy. As the numbers above show, this strategy brings dependable high returns over longer periods of time. There are also more active investment strategies which can bring good results. However, it is advisable to obtain professional investment counsel when using active strategies.
Michael Zienchuk, MBA, CIM
Investment Advisor, Credential Securities Inc.
Manager, Wealth Strategies Group
Ukrainian Credit Union Limited
Mutual funds and other securities are offered through Credential Securities Inc. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Unless otherwise stated, mutual funds and other securities are not insured nor guaranteed, their values change frequently, and past performance may not be repeated. The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This article is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell any mutual funds and other securities. The views expressed are those of the author and not necessarily those of Credential Securities Inc.®. Credential is a registered mark owned by Credential Financial Inc. and is used under licence. Credential Securities Inc. is a Member of the Canadian Investor Protection Fund.