New investors are facing a dilemma.
They might have recently come into a large amount of money due to a business sale or inheritance, or perhaps they’ve been sitting on term deposits for months now waiting.
They know they want to invest, but they are troubled by the question, “Do I invest now, because now seems like a frightening time to invest. Or, if I invest at all, should I drip feed my money in over the course of the next year?”
It certainly doesn’t help to see headlines like “When will the stock market stop going down?” (1)
However, the above questions and headline have one thing in common – the issue of timing.
I remember years ago when I was a younger adviser and a prospective client walked into the office. They had money to invest but markets were volatile. Our firm suggested they should ignore the headlines and the market volatility, and invest now.
“Now?” the investor replied, “But the market is going down.”
That’s when I heard words from an older and much wiser adviser, that I have never forgotten. “No,” he said, “the market isn’t going down. It’s gone down, and it takes wisdom to know the difference.”
So, what’s the difference and why does it take wisdom to know?
“Going” implies something is in the process of happening and that you know where it will end up. When you say the market is “going” down it suggests it is merely in the process of continuing to fall, and you know the market will go lower from here.
If you say instead that the market has “gone” down, it implies that you know what has happened, but you don’t necessarily know what will happen next. That is wisdom.
Since the “going down” headline ran less than a month ago, the world share index is up about 15%. Was the market really “going” down? Can you ever know where the market is “going”? No, you only know where it’s been.
To demonstrate this, we have summarised in the table below the long term performance data of the S&P 500 Index after it has experienced declines. First, we identified any decline of greater than 5% (month end to month end) since World War II until the end of 2019. There were 39 separate instances of a decline of 5%. Then we looked at declines of 10%, 15%, 20%, 25%… all the way up to 50%.
From the point each decline was observed, we then calculated the median return over the subsequent 12, 24 and 36 month periods. If it was true that a decline at any point in time was evidence the market was “going down”, then we would expect to see that a 5% decline predicts at least a 10% decline, and so on. In other words, we’d expect the median return after any decline to also be negative.
But that’s not what the data shows. What we see is that every time we observe a decline, median returns over the next 12, 24 and 36 month periods are always positive, without exception.
Recently the world equity markets experienced a greater than 30% decline peak to trough. History tells us that once such a decline has been observed in the past, the median return 12 months later is a positive 9.80% and 24 months later it is positive 27.94%. This analysis can’t rule out the possibility that a 30% decline may lead to a greater decline 12 months later. But history tells us that, on average, that is not what we should expect.
All of this provides some context to the dilemma faced by the investor with cash to invest right now. Do they invest? Do they delay? Do they drip feed in slowly over time?
The reason you would delay, or put assets in slowly, is because you have some expectation that prices will fall. If they do, you would be better off waiting. But where is the evidence that prices are going down from here, relative to even a 12 month time horizon? You don’t get that evidence based on an analysis of history, and you certainly don’t get that evidence from newspaper headlines.
Back in 2017, Consilium NZ Limited conducted a study looking at a 60% share and 40% fixed interest portfolio. They analysed how often investors were better off investing their cash all at once compared to stretching it out by investing a bit at a time. Consilium’s findings were that since 1990, you were better off approximately 70% of the time by investing all your money all at once (2).
In other words, if you decide to delay investment, you are likely to give up some potential returns. But, even then, there is still a 30% chance that drip feeding could end up being better. Whilst historical analysis can help guide us, the future, as always, is unknowable. And it is impossible to know, with perfect foresight, when it is the right time to invest.
I’m reminded of the quote, “They say, timing is everything. But then they say, there is never a perfect time for anything.” (3)
Maybe I’m saying the same here. There is never a perfect time.
If you looked unemotionally at the history of markets and of similar investment decisions, you’d go with the odds and invest everything now. However, if you have a tendency to suffer from a fear of regret (4), which, by definition “can play a significant role in dissuading someone from taking action,” then perhaps you would be more comfortable to drip feed over time.
Putting in something has a higher expected return than doing nothing. If you can overcome that psychological barrier then perhaps the best advice is:
Invest only when you have cash and don’t need it. Withdraw only when you need cash and don’t have it. Beyond that, laugh, love, live and relax.
- Study uses Consilium model portfolios from Jan91-Dec17. Risk free asset is NZ 1m bank bills. Returns are in NZD returns and are net of fund management fees, but before custodial, administration, adviser fees and transaction costs, and before tax.