Earn 13% Per Year by Timing the S&P 500 Like a Boss
Perfect foresight is certainly profitable
I wrote an article a few weeks ago titled: Why You Should Try To Time The Market. My aim was to provoke and challenge conventional wisdom about market timing.
Key findings from my previous article
The article was not really a case for why you should try to pick market tops and bottoms. I still don’t believe that is possible for any investor to do accurately. Instead, it was to challenge how some of the conventional studies “prove” market timing is bad.
They often do this by excluding the 10 or 20 best days from returns over a long period in the stock market. And then show the significant difference that missing those days would have to your returns.
My purpose was to dig into this analysis a little further. Partly to display flaws in those studies. But also in doing so gain insight that might inform investment strategy.
Without recreating the full article here, some of the key conclusions were:
- The “best days” actually tend to happen during bear markets.
- So, whilst it’s true that missing them is bad, if you also miss the months/years around those days, you can be better off.
- As such, there may be strategies by which dedicated, well-informed investors can make market timing work. But it’s really hard.
- So for the majority, not trying to time is still probably the safest option
The article drew some good discussion and Andrew Plummer wrote a great subsequent article that explored the same concept. You can read that here.
However, the follow-up I wanted to do here was triggered by a question from Michael Petryni.
He asked, “what would happen if you missed the worst market days?”. Again, I’m not saying this is easy or possible. But I was intrigued to know the answer.
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So that’s what I’ve explored here, primarily for a bit of fun.
What happens if you miss the worst days in the market?
Similar to last time, I’ve:
- Taken the period of analysis from 1 Jan 2001 to 31 Dec 2020 (i.e. 20 years).
- Used the S&P 500 as my index to analyse.
- Assumed an initial investment of $10,000.
I’ve then compared what that investment would have been worth at the end of 2020 under 3 scenarios:
- Investor stays fully invested
- Investor misses out on the 10 worst days
- Investor misses out on the 20 worst days
I’ve shown the outcome in the chart below.
As you can see, if you were a market timing boss, you would have made some serious returns:
- If you missed the 10 worst days you’d have made $79k rather than $29k. Or an average annual rate of return of 10.2% rather than 5.5%.
- Similarly, if you've missed the 20 worst days you’d have amassed an eye-watering $121k. A whopping 13.3% annual return!
Like in my previous article, I’ve also looked at what would happen if you missed the entire months during which those worst days occur.
In this case, you can see you are still better off, however, your returns are lower than if you’d miss just the individual days themselves.
This makes sense considering one of the conclusions from my last article. The best days often occur during the worst periods in the market (i.e. during bear markets).
The position is the same if you were to miss out entirely on the entire years that contain those worst days.
Again, your returns are lower than just missing the bad days, as you’d expect. Furthermore, you’re spending significant time out of the market and therefore risk the opportunity to earn a return altogether.
However, it still does suggest there could be some return in market timing if you are able to identify those bad periods for equities. The problem is, that is still really tough.
Final thoughts
My overall conclusions remain similar to my last article which are:
- If you find yourself caught in a bear market, don’t panic. Panic selling could mean you miss the opportunity to capture the “good days” in those downturns.
- If the market crashes and you have some dry powder lying about, consider increasing your exposure. Buy into the downturn.
- If you have stumbled onto a perfect market timing strategy, be sure to let me know. I could do with a 4x increase to my returns…
My original article is included below.
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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
