I used to split the management of my wealth between myself and a licensed financial advisor. According to our arrangement, I was doing the crazy tech investments and he was doing the boring 6% a year investment as a safety net because at that time I thought I needed to diversify. Like millions of others, at the beginning of the COVID crash I exited my positions and wanted my advisor to do the same. But, like most professionals, he didn’t agree with me. Even when we hit a roughly 25% loss, he continued on with his position, showing me a graph like this, which you may have seen throughout your investing journey.
Source: Putnam investing
This graph represents a known data point about the impact of high-performing days on one’s portfolio:
“If you had missed only the 10 best performing days of the market during the last 20 years, you would have halved your gains, so don’t try to time the market!”
I’m a big believer in the insights that can be gained from data and statistics, so when he showed me such clear evidence that missing only 10 days of trading out of over 2,500 could have such a dramatic impact on my future return, the information hit me like a bolder. I was immediately convinced of the argument to become a long-time holder.
Timing the market
For those who have seen numerous stock market corrections knows that these stats about timing the market always resurface during low-performing times. They were all over the news in 2016, 2018, 2020, and most recently during the January 2022 pullback.
One of the issues with these numbers is that they are presented without any context of the high-performing market days. Without knowing when these days occur, or how the stock market performed on these record-setting dates, we only get half the story. Here are the dates of the 10 best performing days on the S&P 500 over the last 20 years:
Do you see a pattern? The days with euphoric returns all happen during massive drawdowns characterized by high volatility, for instance, the 2008 Financial Crisis or the COVID crash. The day with the single highest return over the last 20 years, October 13th, 2008, happened after seven consecutive red days where the market melted by 22%. All the gains on this rebound were erased two days later.
Here is a graph of the market during this period:
In a span of just two months, the market saw a drawdown of around 40%. Taking this context into account, the idea of being out of the stock market and missing these two massively positive days, suddenly shifts from a bad move to a genius one. Because the best performing days are surrounded by some of the worst performing days, this idea of losing your gains if you are out of the market for those 10 best days is simply a myth. On the contrary, if you were to miss those days, you are probably also wisely missing some of the worst days in the market.
Here is table showing data compiled by Bank of America:
The benefits of missing market highs and lows
Although we again see that missing the 10 best days of a decade will negatively affect your return, we also see that missing the worst days of the same period have a positive effect of an even greater magnitude. This indicates that missing both the 10 best and 10 worst days of each decade allow one’s portfolio to outperform simply by buying and holding the same asset during that period. This is tied to one reality of the market: the downward move during a stock market correction is always considerably faster than the upward momentum during the recovery phase.
What is behind this market myth?
Now that we know that the 10 best days of the stock market always happen alongside the worst days, and that missing both of them actually allow you to outperform the market, why is it that even Fidelity tries to scare investors with the risk of missing the market’s best days?
Is it an intentional attempt to deceive investors? I personally don’t believe it is a malicious strategy. Fidelity doesn’t wanting investors to withdraw their capital and accelerate these drawdowns and also likely want to avoid their investors seeing immense losses in their portfolio. They know that people are very bad at timing the market and they want investors to avoid grinding their capital by selling the bottom and buying back at a higher price. They also know that once people start to lose money, they become scared of the market, often don’t re-enter, and lose opportunities to regain returns during the recovery phase that follows in a stock market correction.
Timing the market
We have been playing with stock data for countless hours and even had super-computer run algorithms with hyper parameter optimization and machine learning to try to figure out the optimal timing for protecting our own capital.
Contrary to what we believe, it’s incredibly hard to find market conditions that are forward correlated with being a good time to enter or exit the market. We have back tested countless well-known strategies based on, for example, tracking different exponential moving average cross-points to realize that over a long period, they are actually eroding capital.
Therefore, believing that us humans, based only on viewing the price action and the news, can figure out when we should withdraw our money from the market, is an utopia. There is a reason why buying and holding is a strategy so popular: on a long period it works 100% of time at the index level. But the psychology of committing to this strategy can be a challenge when handling volatile assets. As a tech investor, I have experienced that firsthand.
At WealthUmbrella, we have conducted extensive research and analysis on conventional and alternative datasets to develop tools that we can use to react successfully to big market moves. We don't claim that we have found a way to predict exactly what the market is going to do. On that matter, we're like everybody else - with a beer in hand, we can speculate on various theories about what the stock market will do in the future and be as successful as when we speculate if the Montreal Canadiens (our hockey team) will make the playoffs this year. But what we have done is use an incredible amount of past data to develop tools that tell us if the stats currently favor being in or out of the market. So, I prefer to see these tools as reactive rather than predictive. With these strategies, I am not scared of a drawdown, let alone missing the 10 best days of the market.
(P1_2022)