This content is for information and educational purposes only. It should not be taken as financial advice or investment advice. To receive tailored, regulated financial advice regarding your affairs please consult us here at Hanson Financial Services (financial advice in Liverpool).
Many investors have a fantasy about their portfolios. One day – before they have invested any of their money – the market crashes (like it did in March 2020 when markets reacted to COVID-19). Just as the market hits its trough, the investor puts all of their money in. Over time, the market steadily rises, beating its pre-crisis low-point, and the investor makes huge profits. Just as the market is about to go “bust” again, however, he cashes out again to crystallise his gains and avoid any damage to his investments.
Does this sound realistic? Whilst many YouTube channels and marketing from trading platforms may lead you to believe that it is possible, the reality is that it is very difficult for even the most professional investors to achieve it consistently. In this article, our financial planning team here at Hanson Financial Services in Liverpool explains why it is so difficult to time the markets – and why a long-term strategy of “time in the markets” is almost always a better strategy.
Why it’s so hard to beat the market
One of the main reasons it is hard to beat the market is that the pattern of returns in an index is usually skewed. In other words, the majority of stocks in an index generally perform badly whilst a small number do well and pull the average up. The S&P 500, for instance, has been held up throughout the pandemic largely by growing tech stocks such as Apple, Microsoft and Alphabet (Google). This is why purchasing a few specific stocks typically leads to bad performance.
Other factors contribute to making stock-picking difficult for investors. There is the uncertainty of events which can impact a company’s share performance. Coca-Cola, for instance, recently lost $4bn in market value after Cristiano Ronaldo seemed to snub the brand at a press conference. Such an event would have been impossible for most investors to predict and get ahead of. This is setting aside the wider economic and political environment – with its thousands of unseen forces moving within – which constantly changes and is impossible to fully map even by the best stock market analysts. How many of them saw the turmoil that would come in March 2020 as a result of COVID-19? Hardly any.
Taken together, this helps to explain why most active fund managers (i.e. professional stock pickers) fail to beat their index benchmarks. One famous scorecard, for instance, shows that the S&P 500 has beaten 60.33% of active fund managers over a 1-year period. Over 3 years, this rises to 69.71% and up to 75.27% over 5 years. This is not to say that there can never be room for actively managed funds within a portfolio. Certain investments such as ESG (environmental, societal and governance) are still largely concentrated in active versus passive funds in 2021, although this is steadily changing. As such, an “ethical investor” may still choose to include a larger portion of active funds in their wider asset mix to try and align their capital commitments with their personal values.
Implications for investors
Some people may hear this and think that it is better to avoid equity investing altogether. Yet it is important to recognize that, over the long term, markets tend to recover from their “busts” and go on to surpass them. The FTSE 100, for example, crashed from a 2020 highpoint of 7,674.57 down to 5,190.78 in March as lockdown started across the UK. Some investors panicked and fled the market at this point, crystallising heavy losses in the process. Yet those who remained patient will have likely seen this rewarded. At the time of writing on the 17th June 2020, the FTSE 100 is up to 7,155.65 – not quite back to pre-covid levels, but heading in a good direction.
This suggests that retail (“ordinary”) investors generally do better when they “buy the market” as a whole and hold it for a long period of time – rather than buying individual stocks to try and beat the market. This entails buying investments like index funds, which follow the equity markets as they move up and down in the short term, but which also tend to move steadily upwards over a course of years/decades. Investing in this way can be deeply uncomfortable for some investors who are very risk-averse. In which case, it may be appropriate to consider other asset classes for your portfolio which offer lower returns, but involve lower volatility (e.g. fixed-income, low risk assets such as gilts – UK government bonds). Another way to mitigate equity fluctuations is to diversify your investments across a range of markets, companies and countries so that you are not overly-exposed to sharp movements in individual stock prices.
Are you interested in talking to a financial adviser about your pension and investment planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
You can call us on:
Liverpool Office: 0151 708 7616
Manchester Office: 0161 401 0991
Chester Office: 01244 960 039Or email via: [email protected]