Minding the Markets Mind Games
I was in my wife’s store the other day when a husband and wife walked in looking for glasses (Laura is an optician). While the wife was browsing, the husband and I started chatting and eventually he asked what I did for a living. After telling him that I’m a financial advisor we began talking about investing, that he day trades his and his wife’s accounts and that he had recently liquidated their entire portfolio. I nodded politely and said the market can be unpredictable. As a professional my first instinct was to extend some friendly advice, however not knowing what they had owned or when he actually sold his investments it was impossible for me to say whether or not he acted prudently. Our conversation made me think about how investors react when they become fearful because the markets have become unpredictable.
The old adage of “it’s not about timing the market, it’s the time in the market” rings very true, especially when recent financial news is almost all negative, markets are volatile and if you are in the habit of watching BNN. The general cost of liquidating an account can be quite high and not just because of the transactional costs. The biggest cost can come from not being invested when the market moves in your favour. It is next to impossible to time the market in the short-term; the surprise of the recent plunge in oil prices illustrates this.
Chart #1: iPath S&P GSCI Crude Oil 1yr Return
Chart #2: iPath S&P GSCI Crude Oil YTD Return
The first two charts show the one year rate of return on the iPath S&P Goldman Sachs Crude Oil Index (GSCI) is -49.98% and a current year to date return of -9.58%. This would seem to justify a reaction to liquidate and we can add to our confirmation bias by looking at the return of the S&P 500 and TSX from their peak in 2014 to now.
Chart #3: S&P Peak 2014
Chart #4: TSX Peak 2014
As shown, the S&P is down -3.79% and the TSX, with its far heavier weighting in energy, is down -10.05% from their 2014 highs. Investors tend to focus on the most negative numbers, so let’s take a step back and look at what staying invested over the 12 month time period (charts 1 and 2) would have looked like.
Chart #5: S&P 500 1yr Return
Chart #6: TSX 1yr Return
The S&P 500 had a respectable 8.81% rate of return, and if you were a Canadian who had been invested in the U.S. market you would have also seen a boost from the depreciating Canadian dollar. According to Christian Charest of Morningstar, “The U.S. equity category gained 17.3% during the year, reflecting a 13.7% gain for the benchmark S&P 500 Index as well as an 8.3% depreciation of the Canadian dollar versus its U.S. counterpart.”
Chart #7: CAD vs. USD 1yr Return
In comparison, the TSX had a very mild 2.26% return over the last 12 months. Staying invested in a relatively inexpensive ETF would have kept you positive, even with the 10% drop from its high.
That being said, Mr. Charest also points out that diversified Canadian equity funds showed a solid 10.4% return over the same period largely because of the strong Canadian financial services sector. This is a very strong case for staying disciplined as well as staying invested. Robert G. Allen once asked how many millionaires you know who have become wealthy by investing in savings accounts. The answer is none.
The moral of the story is that it is nearly impossible to time the market accurately. There has been lots of speculation as to when oil might recover or if it’s going to continue to decline. It has been my experience that short-term predictions have a much higher potential of being wrong then keeping a long-term view and staying disciplined. My wife and I talk frequently about our respective businesses and why it’s important to stay focused on the fundamentals of what makes us successful. That is good advice when thinking about the stock market; understand what you’re investing in and why.
Sources: Yahoo! Finance, Morningstar