by: Robert Davis, CFA, CAIA

We all may know someone, maybe ourselves, that believe the key to investment success is being able to “jump out” of the market when it starts to go down and get “back in” when the market starts to go up. Sounds easy, right?  Well, not really.  The problem is that an investor needs to be right twice, which is kind of obvious but harder than one might think when it’s put into practice.  To put some math behind it, if we assume an investor is right 65% of the time, then the probability of “getting it right” twice in a row is 42.3% (i.e., 0.65×0.65).  Essentially an investor’s odds of success are nearly identical to winning a blackjack hand at a casino!

Market drawdowns have a way of drawing out investor emotions at exactly the time an objective (unemotional) and long-term mindset is most needed.  Round Table Wealth Management is not comprised of Spock-minded Vulcans, but as advisors we are able to step back and assess a situation as a third party.  This perspective is critical, especially during stressful periods in the market because long-term investing and risk management are the true keys to success.

As an example, the chart below shows the daily performance of the S&P 500 Index from September 1, 2008 through March 31, 2009, “The Great Financial Crisis”. Evident in the chart below is the massive market volatility during the period. 


The red bars reflect negative returns that rank within the Top 10 Worst Daily Returns for the S&P 500 since January 1980. The green bars are positive returns that rank within the Top 10 Best Days of the S&P 500 for the same period.  There are two key take aways from this chart:

  1. The worst returns occur within close proximity and are followed by some of the best returns. An investor that “jumped out” of the market would more than
    likely not have “jumped back in” due to the recency of the huge selloffs and an unchanged “risk off” mindset.
  2. Now let’s think about the long-term impact. For our fictious investor, let’s assume that they had the misfortune of starting their investing on September 1, 2008, and “jumped out” of the market at the end of the day on October 15, 2008 because the market became too risky. Furthermore, let’s also assume that the investor “jumped back in” on December 1, 2008 and stayed fully invested until May 18, 2022.

The net result:  If our investor had stayed fully invested the entire time, they would have achieved an annualized return of 8.5%, equivalent to 3.05x multiple on invested capital. In comparison, by trying to time the market, the investor still generated a positive return, but only a 7.7% annualized return, or a 2.77x multiple on invested capital. By being out of the market for 47 trading days the investor incurred an opportunity cost of roughly 10% less cumulative return over that time frame … on $1 million that equals $100,000!

In summary, while investing for the long-term creates a higher probability of success, it is equally important to manage risk within the framework of your investment goals.  Staying fully invested does not mean “set it and forget it”.  Diversification across asset classes with low correlations and selecting sub-sectors within assets class that pose less risk can allow investors to remain invested and minimize the key drivers of the market’s weakness. 

New developments in investment products such as hedged equity exchange traded funds based on passive indices are also a great way to remain invested while limiting downside risk.  As David Kelley, Head of JP Morgan’s Global Market Insights Team, stated years ago, “the market doesn’t settle down, it settles up”, and hedged strategies and lower risk allocations allow investors to get it right twice.

Please contact us to discuss this further or any other investment topic.
We welcome your questions, comments and insights.

908-789-7310  |

Sign Up For the Round Table Newsletter