Buy-and-hold: the best and worst of days

While the message is one that I entirely agree with, I can't help but find Chart 1 irksome. On first sight, it seems convincing. But on second thought, isn't this analysis simply a statement of the blindingly obvious. Of course, if you miss out on the 10 or 20 best days in the market your returns will be rubbish. And hey, look what happens if you miss out on the 10 or 20 worst days in the market (see Chart 2). You've got it, you do marvellously. If Chart 1 is screaming 'buy-and-hold', Chart 2 is hollering 'time-the-market'.

The real reason that attempting to time the market is folly for most investors is that our brains are hardwired to be rubbish at it. The field of behavioural finance has found evidence for this time and again, some of which is discussed in our recent IC Book Club. Put simply, greed and fear push us to buy high and sell low. Even armed with the knowledge of this in-built psychological pitfall, most investors are unlikely to ever overcome it in the event that they attempt to time the market.

What's more, timing the market takes a lot of precision. My quick study of the FTSE All-Share's 10 best and 10 worst days over the last decade shows that they have all occurred so close together that an investor who managed to move out of the market to avoid a very bad day would probably end up missing a very good day too.

Three-quarters of the best and worst days seen by the FTSE All-Share over the last 10 years happened in the in the 55 trading days between 19 September 2008 and 8 December 2008 - equivalent on average to one 'big' day out of every 3.7. What's more, during this 55-day period the 'big' days were almost evenly split between up days (seven in total) and down days (eight in total). And aside from one lone top-10 up day in May 2010, the other two top-10 up days fell within two trading days and five trading days of a top-10 down day (see table).

The top 10 up and down days for the FTSE All-Share over the last decade (to 27 Aug 2015)

Source: Thomson Datastream

The likelihood of picking just the good days from these periods of craziness seems pretty slim. So, supposing you ended up out of the market during all the 10 best and 10 worst days. Well, as Chart 3 shows, while hardly an indictment of market timing, you'd have put in a lot of effort for a very modest reward. But by far the more important consideration is the finding by behavioural finance academics that suggests investors are much more likely to be out of the markets after it bottoms out than they are after it tops out.

So, buy and hold; but not on the basis of these charts.

But for those of us who are advocates of buy-and-hold, that leaves the question of how you effectively communicate the message? An honest way would be to simply say: 'Don't try market timing because statistically speaking you'll probably be rubbish at it'. Perhaps there would need to be a risk-warning too along the lines of 'you can make big money market timing as well as losing your shirt'. But this kind of message is hardly marketing gold - in fact, it's so heavy handed investors could even start abandoning buy-and-hold in protest.

In fact, from the perspective of promoting buy-and-hold, irksome Chart 1 actually looks incredibly effective. The chart focuses the viewer on what there is to lose by getting out of the market. And as the behavioural finance academics have shown time and again, the pain felt from a loss is far greater than the pleasure derived from an equivalent gain. What's more, faced with Chart 1, most of us probably realise 10 such valuable days would be easy to miss (we tacitly recognise our market-timing may not be that great) and intuitively most investors will probably correctly suspect that big up days tend to happen close to big down days. Conclusion: best to buy-and-hold.

So, on reflection, and ignoring of the paucity of the analysis, those marketeers that wheel out Chart 1 when markets plunge really know what they're doing and may be doing a lot of investors a big favour.