This graph shows why investors should never try to time the stock market
Timing the market is difficult at best, even for the most seasoned traders.
Now Bank of America has quantified how big the missed opportunity can be for investors trying to get in and out at the right moment.
Looking at the 1930 data, the company found that if an investor missed the 10 best days of the S&P 500 per decade, the total return would be 28%. On the other hand, if the investor had stayed stable through the ups and downs, the return would have been 17,715%.
When stocks fall, a natural impulse can be to hit the sell button, but the company found that the best days in the market often follow the biggest declines, so panic selling can significantly lower returns for longer-term investors by getting the best days miss.
“Staying invested during turbulent times can help recover post-bear losses. It takes an average of 1,100 trading days to recover post-bear losses,” said Savita Subramanian, head of US equity and quantitative strategy at the Bank of America.
Sometimes, like 2020, the recovery is much faster.
The data comes from a boom in retailers trying to find the next Tesla or Gamestop pop, and with the proliferation of data-driven strategies on Wall Street. However, Bank of America noted that simple long-term investing can be a “recipe for avoiding loss” as 10-year returns for the S&P 500 have been negative only 6% of the time since 1929.
Of course, the data also shows the astronomical returns for any investor who correctly got the ten worst days of each decade – at 3,793,787%. Without the 10 worst and best days, there would have been an increase of 27,213%.
However, given the difficulty of pinpointing the ups and downs, it’s better to just stay invested.
Bank of America found that factors such as positioning and momentum tend to outperform in the short term, but fundamental analysis wins over several years.
“While the valuations explain very little returns over the next year or two, they have explained 60-90% of subsequent returns over a 10-year horizon,” the company noted. “We haven’t found a factor with such strong predictive power for the market in the short term.”
Looking ahead, Subramanian expects the S&P 500 to return more subdued returns, or around 2% annually, over the next decade. Including dividends, the return is 4%. The forecast is based on a historical regression of today’s price in relation to the normalized profit ratio.
The company added that in previous periods of similar returns, including between 1964 and 1974 and 1998 to 2008, there was a higher probability of loss, indicating the benefits of long-term investment.
– CNBC’s Michael Bloom contributed to the coverage.