Stockmarket thrills and spills are in the timing

Basic mathematics will tell you that if you get the timing right - buying low and selling high - the rewards will multiply accordingly.

But market timing is a two-way street with often confusing and at times conflicting signposts.

For example, if you had bought into the market on rebound Tuesday (August 9, 2011) around midday when the S&P/ASX200 index dipped below 4,000 for a short time, you would have made a timing call that gave you bragging rights for at least the next week.

But timing long-term investment decisions is a bit more complex.

So a week later with double digit gains on paper, what would you do? Take the profits and sit in cash for awhile? Let it run? These are the sorts of dilemmas gamblers the world over face every week.

Understanding the difference between investing and speculating is critical here. And it is easy to see how the boundaries get blurred when people turn on their TVs for the evening news and see how sharemarkets the world over are yo-yoing around.

Tuning out the short-term noise is a considerable challenge even for seasoned investors at times like these because the size and speed of the market moves certainly make for dramatic headlines. But let's widen the frame and try to put a bit of context around these market moves. If you look back over 30 years of the Australian sharemarket - July 1, 1981 to June 30, 2011 - you will discover that $10,000 invested in 1981 would have grown to more than $229,000 by June this year, a return of 11% a year if all income was reinvested but before tax was paid. The critical assumption is that the portfolio was fully invested in the S&P/ASX All ordinaries accumulation index for the full period.

Now let us look at what would have happened if you had missed 10 of the best trading days in that 30 year period. The result would be a lower return of 9.1% a year but in dollar terms the impact is more dramatic. Because of the compounding effect the $10,000 investment has only grown to just over $134,800.

The natural question that flows is why would you have missed those 10 best trading days?

Well one of the interesting challenges facing anyone trying to time sharemarkets is that the good days and the bad days tend to cluster together.

For example, 4 of the 10 best trading days in the past 30 years were in the month after the October 1987 crash.

In the case of the global financial crisis that really hit its stride in September 2008 before bottoming out in March 2009, the period included two of the best trading days in the past 30 years.

Drill down another level into the volatility of market prices by looking at the days that were either up or down 3% on the day and the difference between recent market moves and the heat of the GFC is also clearly on show.

In October and November in 2008 the Australian sharemarket had 10 days when it registered a gain greater than 3% on the day.

In the same two months there were 11 days when the market fell by more than 3% in a day. That serves as a potent reminder of the volatility we lived through at the time.

By contrast on August 12, 2011 this year we had a solitary day of plus or minus 3% (sadly it was on the minus side of the ledger).

There are of course alternative courses to the volatile road of a 100% sharemarket investment.

One option that a lot of investors are clearly favouring at the moment is to be in cash. Given current term deposit rates and the security factor, that is easily explained. But by its nature it is a timing decision because over the 30 years to June, cash grew a $10,000 investment in 1981 to $133,000, coincidentally close to the return the investor who missed the top 10 trading days achieved over the same period.

The other option is a diversified portfolio approach where the asset allocation is aligned with your age and risk profile so that the volatility of the sharemarket is dampened down by fixed interest, cash or property.

Perhaps diversification is something of a passion killer, but the question is how much excitement do you want when it comes to gambling with your retirement savings?

Data sources: Andex Charts and FACTSET (calculation by Vanguard).

Past performance is not an indication of future performance.

The following article has been sourced from Vanguard Investments Australia Ltd.

Important Information

The above information provides an overview or summary only and it shouldn’t be considered a comprehensive statement on any matter or relied upon as such. The above information doesn’t take into account your personal objectives, financial situation or needs. It’s important for you to consider these matters before making any financial decision and I recommend you seek help from a financial adviser.