When timing isn’t everything: Why systematic investing could reap rewards
Every night when we go home, we turn on the evening news and hear stories about people all around the world who are being affected by today’s financial markets crisis. Never has there been a time with so much uncertainty in a world that we depended on to be the foundation for our financial security in building our dreams for tomorrow.
The wild market swings of Wall Street and the global markets could scare you into thinking that now is the time to make an exit, but a recent report by DALBAR, Inc., the nation’s leading financial-services research firm, suggests just the opposite.
In its in-depth research study, QAIB 2008: Quantitative Analysis of Investor Behavior, DALBAR found that mutual fund investors who hold their investments are far more successful than those who time the market.1
If you don’t know when to get out, stay put
Market timing occurs when investors try to predict future market activities, ideally buying low and selling high. As one can see by the chart below, although investors guessed right more than wrong when it came to timing the market, the periods of incorrect guessing had an impact on their portfolios. Take a close look at the chart; investors, of course, were able to guess correctly when the markets were on the rise, but it was during difficult times like the ones that we are experiencing now that were the most detrimental to their investments.
Here at Aberdeen, our investment process is simple, buy and hold. In the QAIB study, DALBAR reports that this strategy could work best for mutual fund investors as well.
When do investors guess correctly? Typically when markets are on the rise.
It’s easier to make the right decision when markets are rising and the fear of loss is on the back burner. The really smart decision is to invest when the market is down.The guess right ratio is the frequency that the average investor makes a short-term gain. One point is scored each month when the average investor has net inflows and the market (S&P 500) rises in the next month. A point is also scored when the average investor has net outflows and the market declines in the next month. The ratio is the number of points scored as a percentage of the total number of month under consideration
Indexes do not take into account the fees and expenses associated with investing, and individuals cannot invest directly in any index. The S&P 500 Index is an index of 500 selected common stocks, most of which are listed on the New York Stock Exchange, that is a measure of the U.S. Stock market as a whole. Past performance cannot guarantee future results.
1. Source “Quantitative Analysis of Investor Behavior, 2008,” DALBAR, Inc. www.DALBAR.com. Data sources: Investment Company Institute and Morningstar Associates.
Start early, keep contributing, and don’t panic
Let’s take a look at two neighbors, Harry and Billy. One night they got to talking about their future plans and how they would both like to add on to their current homes and remain in their location: great schools, close to work, and of course, great neighbors. Over the course of 20 years, they both invested a total of $10,000 in equity mutual funds. During that time, the market saw many good days and many bad days. Billy, being the calm and cool optimist that he was, kept his money invested, contributed monthly to a systematic investment plan, and let it ride out the storms.
Harry was a nervous guy and would buy and sell whenever times got challenging. Needless to say, when it came time to build those additions 20 years later, Billy had a lot more to work with, approximately 50% more appreciation than Harry and 29% more to work with.
Everyone’s investment timelines and goals are different. Now, more than ever, is the time to have a disciplined investment plan. Work with a financial advisor to help you weather this financial storm, help you to protect your investments today, and achieve your goals for tomorrow.
Harry “The Average Equity Fund Investor”
For the 20 Year Period (1/1/88 - 12/31/07)
Harry’s investment plan represents what is know as an average equity fund investor. His $10,000 investment is made in a pattern identical to the average investor behavior for the period and asset class under consideration. Rates of return are applied each month that is identical to the investor return for each month.
Billy “The Systematic Equity Investor”
For the 20 Year Period (1/1/88-12/31/07)
Billy followed a systematic investment plan. His $10, 000 investment was evenly distributed across each month for the 20 years it was invested.
Source: “Quantitative Analysis of Investor Behavior, 2008,” DALBAR, Inc. www.DALBAR.com. Used with permission.
Average stock investor performance results are based on a DALBAR study, “Quantitative Analysis of Investor Behavior (QAIB), 2008”. DALBAR is an independent, Boston-based financial research firm. Using monthly fund data supplied by the Investment Company Institute, QAIB calculates investor returns as the change in assets after excluding sales, redemptions, and exchanges. This method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses, and any other costs. After calculating investor returns in dollar terms, two percentages are calculated for the period examined: Total investor return rate and annualized investor return rate. Total return rate is determined by calculating the investor return dollars as a percentage of the net of the sales, redemptions, and exchanges for the period.
Systematic investing examples are hypothetical and for illustrative purposes only. Systematic investing involves continuous investments regardless of security price levels. It cannot assure a profit or protect against loss in declining markets.