There is a simple lesson for traditional losers: Since you cannot time the market, the only way to make money is by staying in it for as long as it takes.
The Smart Investor did a study covering the period from September 1979 to August 2003, comparing your returns if you had stayed invested in the market at all times - bull, bear and neutral periods - and if you had woven in and out of markets in good periods.
The study tries to bring out the risks and rewards associated with market timing - or the lack of it. It examines what would have happened to your total returns (as indicated by the Sensex) if the market's best and worst months and days are eliminated from the calculations. This is what we found:
The findings (September 1979 - August 2003)
The study shows that by being 'out of the market' for just a few months during this period, the risks and rewards change dramatically when the months missed were those with the highest or lowest returns.
During this 24-year period, the Sensex gave a compounded annual return of 15.90 per cent as it surged from 116 to 4004. So Rs 100 invested in the Sensex in September 1979 would have cumulated to Rs 3,449 at the end August 2003, after 288 months, or 24 years.
The last decade (September 1993 - August 2003)
During this period, when the market saw the arrival of big institutional players and better stock research, the effect of extremes was more dramatic. During the period, the Sensex moved up from 2,634 to 4004, and gave a compounded annual return of 4.28 per cent.
This means you would have been almost as well off letting your money rot in a savings bank account, and clearly better off with money in a fixed deposit.
Perfect timer vs inept timer
A perfect timer - who avoided all the negative months while being in the market in all the positive months - would have grown his investment of Rs 100 into Rs 96,40,556 during the period 1979-2003 - an annualised gain of 61.31 per cent. On the contrary, an inept timer would have reduced his portfolio to Rs 0.72, by compounding annual losses at the rate of 24.48 per cent.
Similarly, a perfect timer would have grown his investment of Rs 100 into Rs 6,562 during the period 1993-2003 - a annualised gain of 51.95 per cent. An inept timer would have reduced his portfolio to Rs 3.82, an annualised loss of 27.86 per cent during the same period.
Conclusion
It is well known that the market does not rise or fall steadily. Instead, there are days or months when the market soars or plunges. What's surprising is that a tiny portion of those brief swings accounts for practically all of the market's gains or losses over decades.
So market timing is perhaps even more difficult and risky than investors have been led to believe. A better way is to stay invested at all times so that you don't miss the big moves when they happen.
Market timing is only for those who are confident of predicting the future. Others would be better off staying invested at all times and routing investments in stocks through systematic purchases, or 'rupee-cost averaging'.
If you had invested Rs 100 in Sep 1979, your investment would be worth (in Aug 2003) . . .