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Time in the market vs timing the market

Read as to why staying invested can be better than timing the market

Time in the market vs timing the market

In one of our earlier stories - 'The power of compounding', we showed how time is the most crucial element in compounding. In this story, we want to take that thought and apply it in the context of timing the market.

There are way too many variables that determine the movement of stocks over a short-time period (a day, a week, a few months or even a year). Figuring out what these variables are and what their interplay will be is outside the realm of possibilities of nearly everyone. So why is it that people are so keen to find out when to purchase rather than what to purchase? What is the need for this speculative behaviour?

If you are someone who is investing for your future, then you should not be buoyed by timing. More time IN the market is way more valuable than TIMING the market. While you can generate a great return if your timing is correct but let's face it, how many can actually accomplish it? You have so many aspects of your life to look after, so how will you take the time out (pun intended) to time the market.

Let's understand this better through investment in Sensex. If you had bought the Sensex at the close of the first trading day of the year 2000 (i.e., Jan 3rd) at 5,375 and held it till December 31, 2021, your return would have been 11.4 per cent CAGR (Note that we have not considered dividends for this analysis). Now let's say that out of the nearly 5,500 days, you missed the top 10 performing days, your return over the period would come down to 7.4 per cent. That is huge. If you had invested Rs 1 lakh, that would compound to Rs 10.8 lakh had you stayed invested. However, if you had missed the top 10 days, your amount would have compounded to Rs 4.8 lakh only (a shortfall of Rs 6 lakh).

Now, let's say you are the clairvoyant who knows when the market will perform poorly. If you managed to miss the worst 10 days, your return over the same period would have been 16.2 per cent CAGR. In monetary terms, your initial Rs 1 lakh would have compounded to Rs 27 lakh. Perhaps this is why speculation is so common in the stock market. People generally focus on the reward of getting the timing right rather than the probability of getting it right. If you understood the probability of making Rs 27 lakh versus Rs 10.8 lakh versus Rs 4.8 lakh, then you might reconsider your decisions. The lack (or perhaps disregard) of such a fundamental mathematical concept is disconcerting. This should have convinced you as to why staying invested is beneficial.

Let's end this article by stating that one should not stay put in everything he/she invests in. That would be unwise. Perhaps Peter Lynch can bring this point home: "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections than has been lost in corrections themselves." If your investments are sound, then the temptation for speculation should be arrested.