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Staying invested beats market timing

Staying invested beats market timing

One should always respect the market and be very careful when talking about performance, as it's easy to create the wrong impression. The market has a habit of surprising, so one should never allow complacency or hubris to take hold, or suggest that it has.

Respect for the market encourages me to stay invested, rather than trying to time entry and exit. Wiser investors than I no doubt make fantastic returns from getting this right, and there are certainly occasions when one taps the tiller of a portfolio. But such an approach can be very costly if you do not get it right.

Recent research by Fidelity shows the dramatic effect on performance when investors miss out on the good days. In the 10 years to October 2010 £1,000 invested in the FTSE All-Share would have grown to £1,330. But this return would have fallen to £720 if the best 10 days had been missed, and £475 if you had missed the best 20 days.

You may have seen findings of this sort before. But analysis of various companies' investment platforms shows that private investors do tend to buy when stocks have had a good run and to sell when they have fallen. It is suggested one reason for this is that retail investors tend to buy for historic reasons - past performance - rather than being focused on the future.

Further research last year took Fidelity's figures a stage further. Missing the best days is not necessarily relevant to most private investors who tend not to be day-traders. Instead, Fidelity worked out the effect on returns if investors had sat on their cash for a year after the market had bottomed. This is perhaps more typical behaviour. When analysing all UK bear markets since 1972, Fidelity found that sitting out the first post-trough year would have reduced returns by 75 per cent over the following four years.

Market commentators therefore urge investors to buy low and sell high. But this is easier said than done. Buying when the market has fallen, when one is surrounded by bad news, is understandably difficult - who is to say the news may not get worse? The answer, in my view, is to take a long-term perspective and stay invested. Time in the market is more rewarding than market timing.

Keeping it simple

Both of my portfolios adhere to simple investment strategies. The first is to keep fees down. Calculations show that a £100 monthly investment left for 40 years attracting a 5 per cent annual return before fees would be worth £150,000. But deduct a 1.5 per cent annual management fee and this would reduce the figure to £105,000. This is why one should avoid unit trusts if possible, which tend to have higher fees, and focus on investment trusts and exchange-traded funds.

I am a particular fan of investments trusts. Not only are they cheaper but, perhaps because of their ability to gear and the fact they tend to be smaller than their unit trust cousins, they are better performers on average. This tends to be true even when comparing trusts with their open-ended equivalents, as an excellent piece in last week's IC showed ('' 1 April 2011). The figures showed that the Templeton Emerging Markets trust (TEM) – a long -term holding in both portfolios - charged 1.2 per cent less a year in fees than its open-ended equivalent, Templeton Emerging Markets Fund, and outperformed the same fund in terms of annualised NAV total return by a whopping 7 per cent.

Keeping it simple also means not taking on too many asset classes. In particular, I would avoid structured products. These have tended to be disappointing investments, with processes which are not always clear. Instead, in my view it pays to stick with four asset classes – bonds, equities, genuine absolute-return funds, and tangible assets such as gold, silver and cash.

Others will disagree and perhaps suggest more. They may be right. But research a couple of years ago by James Norton of Evolve Financial Planning showed that in the 20 years to 2008 a 60/40 split between the FTSE All-Share and Citi Bond index would have produced an annualised return of 8.8 per cent. Eight asset classes would have pushed that figure to 9.9 per cent for relatively little risk. But go beyond that and there is little further return for a lot more risk.

The message is simple: keep it simple and stay in control. The more asset classes you add, the higher the fees - particularly if some of these assets are at the more obscure end of the investment spectrum. Don't be persuaded to do otherwise by slick sales talk.

NEXT MONTH...

John Baron's next monthly column will focus on an additional - although still mainstream - way of gaining exposure to the faster-growing economies of the world, for arguably less risk. He waives his fee for this article in lieu of donations by the FT to charities of his choice.

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By John Baron,
05 April 2011

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