Imagine we have three investors. Each start with a $10,000 investment in the S&P 500 index on Dec 31st, 1989, and from there each investor contributes $1,200 annually to their investment but in very different ways:

Investor 1: is a perfect market timer. This individual knows when the S&P has hit a level on the downside that it will never hit again. This investor perfectly times his $1,200 annual investment each and every year at the corresponding market low.

Investor 2: is the opposite of our first investor. In their attempt to time the market, they get it perfectly wrong each and every year always choosing to invest their $1,200 contribution at the corresponding annual high of the market.

Investor 3: Does not have a clue and they know it. Rather than try to time they market the simply make their $1,200 annual contribution to their portfolio in a systematic way choosing to invest on the first trading day of every year.
Let’s take a look at the results.

Source: Bloomberg, FactSet, RBC WM

The first observation that stands out to me is how relatively small the difference is between the three portfolio ending values for each investor. The investor that was able to perfectly time 30 years’ worth of contributions is only better off by about $30,000 from the investor who decided to simply allocate their deposit at the beginning of each year. It represents a performance gap of 10.5%. Consider that this performance gap was built up over 30 years. On an annualized basis a perfect market timer only improved their performance by 0.32% annually over a systematic investor.

The gap between the “perfect market timer” and the individual that invested on the worst possible day each year is a bit more sizeable at $36,502.93 or a 14.7% performance gap. On an annualized basis the perfect market timer only picked up 0.4% per year of return on the investor who made all of the wrong decisions. Also keep in mind that this scenario illustrates the worst case possible. In practice, it is virtually impossible that an investor would ever be able to perfectly time or mistime the market over a period of a few years, let alone 30.

Why does market timing not really matter?

The above results shake out this way because of the power of compounding returns over a long period of time. Mathematically the effect of compounding is a much more meaningful determinant of long-run returns compared with the impact that year-to-year timing decisions have. In the short run, the market is going to do what it is going to do. Over the long-run, having a seat at the table (i.e. being invested) is what really matters. We believe this is an important message for all of us as investors to grasp. Ideally this should liberate us, and we can stop worrying about timing in the short-run, and focus our efforts instead on making sound investment decisions with a long-term time frame in mind.

A different way to look at market timing

The chart below looks at the returns of $100,000 investment in the S&P 500 made at the beginning of the year 2000 to the end of last year. The yellow line illustrates the growth of the $100,000 investment over the 20 year period, closing at the end of last year at $258,110.12 or an absolute return of 158%. On an annualized basis that is a return of 7.9%.

Now consider that exact same investment over the same time horizon, and the only difference is that we remove the best ten trading days over the last 20 years (the blue line on the chart). The results speak for themselves – they are devastating. Missing the 10 best trading days of the last 20 years would have eroded an investor’s 158% return down to a mere 18.4% or 0.92% annualized. An investor would have done better rolling a 1-year GIC for 20 years. Now of course the likelihood of missing the exact 10 best trading days is as likely as picking the annual low of the market 30 years in a row. However the intention here is to show the peril of making timing decisions that could see us out of the market for even a few good trading days.

Source: FactSet

Digging a little deeper into the data - I want to illustrate the time periods where the 10-best days occurred. In chronological order you can see that the top ten trading days occurred around three events: The collapse of the late 90’s tech bubble in early 2000. The 2008/2009 financial crisis, and the COVID-19 pandemic. Each of these top ten trading days are bookended by very negative trading days and occur during the three worst market events of the past 20 years. These are time periods where investors would have been much more likely to be considering selling stocks, rather than buying more. Thereby potentially exposing themselves to missing these days.

Source: FactSet

Some parting thoughts

I want to conclude by tying together the two examples we have looked at. In the first example we look at how the benefits of making perfect timing decisions only offer a modest reward over taking a systematic approach to investing – remember it’s time in the market not timing the market. In the second example we illustrate the danger of being out of the market on only a handful of critical days. Missing the best days can significantly and substantially alter an investor’s return path for the worse. Further, it has been during times of market stress that these best days fall, which also tend to be the times when investors are the most vulnerable to emotion, and likely to act on impulse.