Whether A Seasoned Or New Investor, Staying Invested Is Your Bet [IOTW: 22 Jun 18]

• While equity markets can be volatile, they often drift in an upward trajectory over time.
• By missing out on the market’s top 30 daily returns, your portfolio’s growth potential could be reduced by three quarters!
• The best market returns often appear in periods when markets are bearish, the key point is to stay invested, as you will never know when it comes.
• Your best bet as investors is to consider a regular savings plan, stick to your objectives and investment horizon, and let market fundamentals work its magic.

 

Investors plough their savings into equity markets for a few reasons, such as to keep pace with inflation, or to grow their money, through capital growth and receiving dividends from companies listed on a stock exchange.

Like most other things in life, everything has its ups and downs, and investing is no exception (see Chart 1).

Chart 1: Indices performance indexed to 100 (end-1988 to mid-2018)

 

However, the return distribution for equity markets are often positively skewed, such that upsides are more common than downsides, thus giving markets an upward drift trajectory (see Chart 2).

 

Chart 2: Return distribution and frequency of MSCI AC World Index

 

Generally markets have been able to reach higher highs over extended periods of time as corporate earnings and valuations grow.

If you started investing from end-1988 with $10,000 in your portfolio, this value would have grown to an estimated $100,000 to $130,000, depending on which markets you invested in, and excluding any form of Regular Savings Plan (RSP) contributions to the portfolio (see Chart 3).

 

Chart 3: Portfolio value of investments in global markets since 1988

 

From the chart above, it implies that a significant portion of portfolio returns are contributed by the 99th percentile of daily returns. Assuming investors miss out on the top 10 daily returns over a 30 year period, their current portfolio value would only be half of an investor's portfolio who stayed fully invested throughout! This large discrepancy can be attributed to the effect of compounding – a topic often talked about and yet cannot be emphasised enough.

Another interesting observation we had is that the markets’ best returns often happen at the turn of a bear market, when markets begin to bounce back from a depression. As seen in Chart 4, the dot plots represent the top 30 daily returns for the respective equity markets, and most of them centred on the trough of the 1997-98’s Asian Financial Crisis and 2007-08’s Great Financial Crisis.

Chart 4: Top 30 Daily Returns

 

Nuggets of Wisdom We Can All Learn From

 

Don’t Catch The Falling Knife

While some investors may think that a sure-way to profit from investments is to invest when markets are bottoming, it is often difficult to do so, since figuring out where the trough is, is often only 20/20 in hindsight. And ploughing money hoping to catch the bottom all at once during bear markets is akin to catching a falling knife, a situation where you may end up with hurting yourself.

Based on recessionary periods over the last two decades (Dotcom bubble/Asian Financial Crisis/Great Financial Crisis), market drawdowns were observed to hover around -40% to -50% at their peaks. This has formed certain expectations for investors, as they believe they can time the markets and invest at that threshold.

However, there are often exceptions to the rule, considering what happened during the Great Depression in 1929, as the Dow Jones Industrial Index experienced a drawdown of 89% at the height of the crisis.

As it was an unforeseen and extreme market whiplash, it is highly likely that many investors today will not have the discipline and tolerance to stay invested, and may instead choose to bite their tongues and grudgingly take the investment losses, should markets decline past historical averages.

Dollar Cost Averaging

Rather than trying to catch the bottom, a simple suggestion would be to layer your investments via a RSP plan, spreading your market entry points, thereby reducing the risks of investing in markets at their peaks.

Certainly utilising a RSP strategy does not fire-proof your investments from losses. It could even probably mean that one has to endure periods of underperformance – which is perfectly fine, since no path to investing is buttery smooth.

Regardless, based on our previous findings, we concluded the RSP strategy to be beneficial to investors both in terms of lower drawdowns, as well as shorter recovery periods during catastrophic crises.

The Power Of Compounding

Earlier on our findings indicate that a disproportionately small number of profitable days contribute to a large proportion of investors’ wealth, based on the hypothetical equity portfolios we have constructed for the various regional and global markets. This can be largely attributed to the compounding effect positive returns have on portfolio values.

For new investors who are uninitiated, compounding is simply the act of generating returns (capital growth/dividends), and reinvesting these returns back to the original portfolio. As more money can be put to work, this compounding effect results in a virtuous cycle of accelerating the portfolio’s income and growth potential.

For the effect to be truly pronounced, it is also important for investors to maintain a longer time horizon across multiple market cycles.

As markets often drift upwards over an extended period of time, the earlier you start investing, the better it is, as you maximise your portfolio’s potential for growth.

Last but not least, remember to stay diversified in whatever investment action you take!

The Research Team is part of iFAST Financial Pte Ltd.