It’s not always easy to stick to your long-term investment goals. Short-term news may give you cause for concern, and you may find yourself questioning whether your decision to invest was the right one. You might be tempted to wait out any bad news by switching your investments into cash.
But is it really such a good idea to move out of the market for a bit?
The historical evidence would suggest not. Here are three charts that explain why market timing is so hard.
Moving to cash in a panic rarely pays off
The first thing to say about trying to time the market is that stocks and shares have historically risen over the long term. UK shares, for example, returned 5.41% on average each year between 1900 and 2020 in real terms1. That’s the return after inflation is taken into account. As such, any decision to sell up and move to cash is implicitly a short-term bet, although past performance is not necessarily a guide to future performance.
By looking at how markets have performed since 1990, however, we can see how likely you were to be successful if you did sell out of the market. We used what’s commonly referred to as a 60/40 portfolio to represent markets, comprised of 60% global shares and 40% global bonds. This is a widespread investment strategy across the world as it contains a mix of growth-seeking assets (shares) and more defensive assets (i.e., bonds).
We looked at four different time scenarios, examining the median impact of selling out over 1, 3, 6 and 12 months each time global shares had sold off by 5%. In other words, our examples look at what happens if markets fall slightly, and you then decide to make changes to your portfolio. The performance figures are for the median, i.e., the middle value from all the scenarios we looked at.
As you can see below, you have a 56.9% chance of underperforming the market if you sit in cash for one month, slightly worse than correctly calling ‘heads’ in a coin toss.
If you stay in cash for 12 months, you have a 78.6% chance of underperforming. In this case, underperforming means having less money than if you’d just stayed invested in the first place. Using data from the Office for National Statistics, someone born today therefore has a better chance of living to 100 than you do with timing the market over 12 months.
Your chance of underperforming if you switch your investments to cash
Past performance is not a reliable indicator of future results.
Notes: The chart shows the probability of excess returns of cash over a global 60% shares/40% bonds portfolio in a one-, three-, six- and 12-month period after two-month total returns of global equities were below 5%. For example, global share returns from 31 August 2008 to 31 October 2008 were -20.74%. Over the following 3-month period until 31 January 2009, cash returned 0.84%, while the 60/40 portfolio returned 1.76%, so that the excess returns of cash were at -0.93%. Shares comprise global shares (MSCI AC World Total Return Index). Bonds comprises hedged, global bonds (Bloomberg Global Aggregate Bond Index Sterling Hedged). Cash is represented by sterling 3-month deposits.
Source: Vanguard calculations in GBP, based on data from Refinitiv, as at 28 February 2022.
It gets even uglier though.
Not only is your chance of underperforming higher the longer you stay in cash, the amount you could miss out on also rises over time. Based on our research above, someone sitting out of the market with a £10,000 portfolio could have missed out on several hundred pounds over the course of 12 months. Our research is based on relative returns, so while you could have experienced a positive return if you moved your portfolio to cash, you would have made more money had you stayed invested.
Timing the market is futile
If you do decide to time the market, you better watch it closely. The best and worst days in markets tend to occur close together, as shown in the chart below. In many cases, the cyan bars (representing the 20 worst trading days) look like mirror images of the orange bars, which signify the best trading days.
The best and worst trading days cluster together
Past performance is not a reliable indicator of future results.
The chart shows daily returns of the FTSE All Share Price Index. The yellow bars highlight the 20 best trading days since 1 January 1980 and the tale bars highlight the 20 worst trading days since 1 January 1980. Source: Vanguard calculations in GBP, based on data from Refinitiv, as at 22 March 2023.
Sometimes, the market’s worst days come entirely out of the blue, as with the Black Monday crash of 1987. What caused Black Monday is still debated to this day, though many blame internal market dynamics with the introduction of automated computer trading.
If people can’t agree on why Black Monday happened, it’s hard to see how they could predict it happening at all.
Geopolitical sell-offs are typically short-lived
What about when something clearly negative happens though, an event with clear potential harm to the global economy or markets worldwide? Few people will remember the 1962 Cuban missile crisis, but the 2016 Brexit vote and Russia’s 2022 invasion of Ukraine may well have tempted some to cash in their investments.
But the problem with the market reaction to geopolitical events is that often doesn’t last very long. In six of the eight scenarios covered below, markets were higher six and twelve months later. Only on two occasions – Russia’s invasion of Ukraine and the impeachment of Richard Nixon – were markets lower a year later.
Bad news doesn’t necessarily last in markets
Past performance is not a reliable indicator of future results.
Notes: Returns are based on the Dow Jones Industrial Average from 3 January 1950 to 31 October 1963 and the Standard & Poor’s 500 Index thereafter. All returns are price returns. Not shown in the above charts, but included in the averages, are returns after the following events: the Suez Crisis (1956), construction of the Berlin Wall (1961), assassination of President Kennedy (1963), authorization of military operations in Vietnam (1964), Israeli–Arab Six-Day War (1967), Israeli–Arab War/oil embargo (1973), Shah of Iran’s exile (1979), U.S. invasion of Grenada (1983), U.S. bombing of Libya (1986), First Gulf War (1991), President Clinton impeachment proceedings (1998), Kosovo bombings (1999), September 11 attacks (2001), multi-force intervention in Libya (2011) and U.S. anti-ISIS intervention in Syria (2014).
Source: Vanguard calculations in USD, based on data from Refinitiv, as at 21 March 2023.
It’s worth noting that there were wider events at play on both occasions for the Nixon impeachment and Russian invasion; namely, changes to the international money system and rapid interest rate rises in the United States and Europe in response to high inflation.
Markets are also quick to price in new information. There are hundreds of thousands of investment professionals worldwide, to say nothing of sophisticated algorithmic trading strategies. By the time you move to sell your investments, the bad news you are acting on will probably already be reflected in the price you receive.
Thinking in bets
You’re really making three separate bets when you try to time the market. Bet No. 1 is that the odds are with you, that you’ll end up vindicated with your decision to sell. Do you really know better than the combined wisdom of all the other market participants that are setting the price?
Bet No. 2 is the reason for the market going down. You might have good cause to think that the market will fall, but as we’ve seen with most geopolitical events, the market can soon shrug it off or there may be wider events at play.
Your third bet is your most nerve-wracking of all – when to get back into the market. If markets have risen, then it’s always tempting to hold steadfast in your beliefs and stay in cash. If you’ve been proven correct on the other hand, and stocks and bonds having fallen, how do you know you won’t be too afraid to get back in?
That’s why we say that for most people, it’s generally best to stay invested.
1 Source: Vanguard using Dimson-Marsh-Staunton global returns data from Morningstar, as at 31 December 2022. Data covers the period from 1901 - 2022. Returns are in local currency.
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