Investing isn’t a science. There’s no guaranteed get-rich-quick formula that can make you a millionaire overnight and any stock promoter who tries to sell you a trading strategy that guarantees profits is almost certainly lying. Indeed, even the world’s most experienced investors and money managers don’t guarantee profits as it’s just impossible to predict the market’s movements.
But despite the fact that it’s beyond tough to know how the market will behave, investors continue to think that they know best. The simple fact of the matter is that this is investors’ biggest mistake.
The biggest mistake
The stock market is driven by human emotion. Therefore it tends to be highly irrational. Trying to predict the market’s movements is a fool’s folly and trying to outperform by timing the market is just as useless.
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Many different academic studies back up these statements. Investment fund powerhouse Davis Advisors looked at the annualised returns of equity investors (based on returns of the S&P 500 index) over the 20-year period from 1994 to 2013. During this time, the market saw two major bull and bear markets, which would have produced very different reactions from investors.
To model these reactions Davis’s analysts compared to the returns of five different investor groups over the period studied. They were those who remained invested over the entire period; those who missed just the best 10 trading days; those who missed the best 30 trading days of the study period; and those who missed the best 60 or 90 trading days.
The difference in returns for these five groups is extremely revealing. The investor that stayed fully invested and rode out the turbulence achieved an average annual gain of 9.2%. However, the investors who missed the 10 best trading days or more saw compound average annual returns of only 5.5% or less.
Another study, this time conducted by consulting firm Dalbar found that since 1984, the average US equity fund investor has lagged the market by an average of 7.3% per annum thanks to attempts to time the market.
Put simply, the above figures show that timing the market (or trying to) is just a complete waste of time, effort and money. Missed opportunities and extra trading/tax costs add up over time.
The bottom line
For the average investor, trying to trade around the market, or using a trading strategy to try and beat the market, is a waste of time. Granted, some investors have the experience to cope with this style of dealing, but they’ve usually learned the hard way.
If you’re looking to preserve your capital, and invest with minimum effort, buy-and-hold investing is the best way to go. For investors who have even less time, index investing may be the best strategy.
If multiple studies have show that the average investor can’t beat the market, it makes no sense to try, especially when there’s such an easy alternative available.
