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Key Points

A range bound stock market has left some investors on the sidelines waiting for the next rally
We conducted a study of historical returns for the S&P 500 between 1928 and 2009 to test the benefits and detriments of timing the market
Avoiding the ten worst months resulted in an annualised 8.3% return, versus the annualised 5.1% return for remaining invested from 1928 to 2009
Excluding the ten worst days of performance in eighty-two years, annualised return improved to 6.6%
On the other hand, missing out on the ten best months and ten best days gave annualised returns of 2.5% and 3.7% respectively
Monthly returns were concentrated between -5% and 5% for a majority of the time
The results suggest that market timing can be a risky strategy which may severely impact returns, if one misses out on the best days or months of market performance

Chart 1: Outliers can make a huge difference!

After some heady gains from the March 2009 lows, the Singapore benchmark Straits Times Index (STI) has been trading in a range bound fashion since late July. Investors have seen the index “trapped” between 2500 and 2700 points, in a trading range of about 8 per cent over the past three months. Some traders have described the market as being in a period of “consolidation”; the less diplomatic ones would simply term the market “boring”.

With limited stock market movement over the past few months, some investors may be tempted to sit on the sidelines, waiting for the next move upwards before investing in the stock market. Is trying to time the market really the best option?

Market timing study

We looked back at historical data (between 1928 and 2009) for the US stock market, which has seen numerous economic cycles to get a feel of the outperformance of an investor who managed to avoid either daily or monthly declines in the market. We also looked at the returns an investor would have obtained by missing the best and worst ten days, as well as the best and the worst ten months for the entire period (end 1927 to end October 2009).

Table 1: Value of $1 invested in the S&P 500 since 1928, with different scenarios
	end Oct 2009	Annualised Return
S&P 500	$58.67	5.1%
avoiding all negative months	$1,404,281,699	29.4%
avoiding all negative days	$105,907,281,414,542,000,000,000,000,000,000,000	167.9%
Source: Bloomberg, iFAST compilations, return in USD terms, excluding dividends)

Throughout this entire period (1928 to 2009), the US economy experienced fourteen recessions (as determined by the Bureau of Economic Research), amongst them the much-touted Great Depression of the 1930s, while the stock market experienced numerous significant crashes (years like 1929, 1987 and 2008 spring to mind). Despite this, the S&P 500 still returned an annualised 5.1% over the eighty-two year period. Thus, a dollar invested in the S&P 500 back in December 1927 would be worth $58.67 at the end of October 2009; excluding dividends (see Table 1).

Taking the study further, we calculated the hypothetical returns if an investor managed to avoid all negative months during this eighty two year period (410 negative months out of the 982 months in the period under study). Such an investor would have grown a single dollar into more than $1.4 billion in the eighty-two years, marking an entry into the popular Forbes billionaires list.

How about an investor who managed to avoid every single negative day in the stock market over this eight-two year period? His net worth would have stood at over $105 decillion, an incredibly large figure (a decillion is 10³³). To put this figure in perspective, the estimated total global economic output was “just” US$60.6 trillion in 2008, and assuming economic output remained constant, it would take the world’s combined economies about 1.7 billion trillion years to generate the equivalent value in GDP.

More realistic expectations

The results we have derived so far suggest that investors who can successfully time the market (either by month or by individual days) may become a billionaire, or even the richest person in the universe. Obviously, the catch here is that it is practically impossible to time the market on a monthly basis with perfect accuracy over such a long period of time. Needless to say, timing the market with perfect precision on a daily basis over eighty-two years is perhaps an art best reserved for the gods.

Table 2 shows the same study with more realistic scenarios. Four scenarios were tested, which we believe are plausible outcomes for an individual investor.

Table 2: Value of $1 invested in the S&P 500 since 1927, with other more realistic scenarios
	end Oct 2009	Annualised Return
S&P 500	$58.67	5.1%
missing top 10 months	$7.64	2.5%
missing top 10 days	$19.46	3.7%
avoiding worst 10 months	$677.75	8.3%
avoiding worst 10 days	$186.33	6.6%
Source: Bloomberg, iFAST compilations, return in USD terms, excluding dividends)

Avoiding the “mines” or “potholes” obviously increased returns

Avoiding the ten worst months increased the annualised return from 5.1% to 8.3%, while avoiding the ten worst days increased the annualised return to 6.6%. This is all well and good for an investor, but begs the question: how does an investor manage to avoid these “potholes” in their investment journey?

But missing the best months or days severely impacted performance

Being unable to forecast the future, we believe that our study of missing out on the top ten months or top ten days may have more bearing on determining an investment approach. In the entire 982 months under study, it is surprising to note that missing out on the best ten of those months halved the actual annualised return of the S&P 500. On an absolute return basis, the 5,770% return of the S&P 500 was cut to just 664% as a result, a very paltry return for almost eighty-two years of investment.

Missing out on the best ten days of market performance in the entire eighty-two year period was less detrimental, but cut the annualised return to 3.7% versus the S&P 500’s 5.1%. On a total return basis, this translated to a 1,846% return.

Markets are “boring” a large part of the time

As shown in Chart 1, monthly returns of the S&P 500 appear to be normally distributed, with 73.8% of the monthly returns in the range of -5% to 5%. These are periods where markets are considered “boring” and often trade in a range bound fashion. However, we believe that investors should be more excited about the positive occurrences (those on the right side of Chart 1), and should ensure that their portfolios benefit when such hefty gains occur. Unless one is extremely lucky, the only way to ensure exposure to these positive periods of performance (just 2.7% of the months under study had a positive return of over 10%) is to remain invested in the stock market and avoid timing the market.

Staying invested is the better option

From the results, it appears that while getting market timing calls right (avoiding worst performing days or months) can generate significantly better performance than the market return, missing out on the best days or months will hurt returns substantially.

Since no one can correctly forecast the market direction with precise accuracy, avoiding the worst periods of performance is not easy, and is sometimes an impossible task. Rather than trying to avoid the large negative-return outliers (shown on the left side of Chart 1), a task fraught with uncertainty, investors can choose to “accept” all the huge positive-return occurrences (on the right portion of Chart 1), a certainty if one stays invested in the market.