Investing in equities has long been considered one of the most effective ways to build wealth over the long term. However, within this broad strategy lies a crucial debate: is it more important to stay invested for the long haul ("time in the market") or to try to capitalise on market fluctuations ("timing the market")? Evidence overwhelmingly supports the former, especially in the context of the Australian sharemarket. This report will explore why staying invested over the long term tends to outperform efforts to time the market, with specific references to the performance of the Australian sharemarket.
"Time in the market" refers to the strategy of maintaining a consistent investment in the market over a prolonged period, regardless of short-term market volatility. This approach is grounded in the belief that markets tend to rise over the long term, driven by economic growth, innovation, and increasing corporate earnings. By staying invested, investors can benefit from compound returns, where gains build upon gains over time.
"Timing the market," on the other hand, involves attempting to buy low and sell high by predicting market movements. This strategy is fraught with challenges:
To illustrate the superiority of "time in the market," let's examine empirical evidence from the Australian sharemarket.
Historically, the Australian Securities Exchange (ASX) has delivered robust long-term returns. According to data from the ASX, over the past 30 years, the All Ordinaries Index (a benchmark of the Australian sharemarket) has delivered an average annual return of approximately 9.5% before inflation. This figure includes both capital gains and dividends.
One of the most compelling arguments for "time in the market" is the impact of missing just a few of the best days in the market. A study by Vanguard Australia examined the period from January 1996 to December 2016 and found that if an investor missed the 10 best trading days over this 20-year period, their returns would be halved compared to staying fully invested. Missing the 20 best days would reduce returns even further.
The Australian sharemarket, like all equity markets, experiences volatility. However, the market has consistently recovered from downturns. For example, during the Global Financial Crisis (GFC) of 2007-2008, the All Ordinaries Index fell by more than 50%. Investors who sold during the panic locked in significant losses. However, those who remained invested saw their portfolios recover and grow as the market rebounded over the subsequent years.
Dividends play a crucial role in the long-term returns of the Australian sharemarket. Australian companies are known for their relatively high dividend yields, which provide a steady income stream and contribute significantly to total returns. Reinvesting dividends can compound returns over time, further emphasising the benefits of staying invested.
Compounding is the process where investment earnings are reinvested to generate additional earnings. This snowball effect can lead to exponential growth over long periods. For example, an initial investment of AUD 10,000 in the All Ordinaries Index at an average annual return of 9.5% would grow to approximately AUD 76,122 over 20 years. Extending this to 30 years, the investment would grow to around AUD 190,128, illustrating the power of compounding returns.
Behavioural finance studies have shown that investors are often their own worst enemies when it comes to market timing. A study by DALBAR Inc. found that the average investor significantly underperforms the market due to poor market timing decisions. Over a 20-year period, the average investor in equity mutual funds earned a return of only 2.6% per year, compared to the S&P 500's average annual return of 8.2%. While this study is based on the U.S. market, similar behaviours are observed in Australian investors.
In the context of the Australian sharemarket, the evidence clearly supports the strategy of "time in the market" over "timing the market." Historical performance data, the impact of missing the best trading days, the role of dividends, and the power of compounding all highlight the benefits of staying invested for the long term. While market volatility and downturns are inevitable, a disciplined and patient investment approach is more likely to yield superior returns compared to the challenges and risks associated with market timing. By focusing on a long-term investment strategy, Australian investors can harness the full potential of the equities market to build wealth and achieve their financial goals.
