IT'S pretty obvious that you should buy when things are cheap and sell when they are expensive. It’s so simple. But guess what most investors tend to do? When the news is good and the investments are expensive, they buy, and when the news is bad and investments have fallen in value, they sell. It’s a recipe for financial ruin.
Good market timing is all about buying at the bottom and selling at the top, and being a market timer means doing just that.
The trouble is, getting your timing right is notoriously difficult. When it comes to investments like shares, which swing in value from year to year, let alone day to day, trying to pick the market isn’t just challenging, it can cost you dearly in terms of your overall returns.
To illustrate this, let’s say you invested in shares ten years ago. In 2000, Australians shares delivered a return of 4.8%(as measured by the S&P/ASX 300 Accumulation Index). Unhappy with this result you bailed out of shares. Yet in the following year, the Australian sharemarket delivered a return of 10.5%. So you bought back into the market. However in 2002, shares dished up a loss of 8.6%.
Clearly, this sort of seesaw approach can see you caught out in terms of market returns.
But here’s the interesting thing. If you had invested in Australian shares and held onto your investment for ten years, by the end of 2009, you would have earned an average annual return of 9%. And bear in mind this includes 2008 when the market recorded a staggering loss of 39%.
The short term movements of sharemarkets are determined by a complex array of factors. Unless you’re a cross between Nostradamus, Albert Einstein and King Solomon, the likelihood of consistently picking the years in which shares will perform extremely well is virtually nil.
Punting (and it is punting) on trying to move in and out of the market at optimal times is a mug’s game. That’s why one of the golden rules of investing is that time in the market is a much safer bet than market timing, which means entering and exiting the market when you think the time is best.
If you do go along with the ‘time in the market’ principle, it solves the problem of trying to choose the right time to invest. For anyone prepared to take a long term approach of say, seven to 10 years or more, the right time to invest is when you can afford it, and ideally now.
Along with adopting a long term outlook, you can further protect yourself from a great deal of sharemarket volatility by diversifying. Holding shares in just one or two companies leaves you dangerously exposed to any misfortunes these businesses may suffer. A better option is to diversify across companies, industries and even countries.
One of the easiest ways to get this sort of diversification is by investing in a managed share fund. You can typically get started with as little as $1,000. And as most managed share funds invest in 30 to 50 different companies, or more, you enjoy exposure to a far wider range of shares than most of us would achieve as a direct investor.
To learn more about managed funds take a look at my book Making Money or visit websites like www.morningstar.com.au.
Paul Clitheroe is a founding director of financial planning firm ipac, chairman of the Financial Literacy Foundation and chief commentator for Money Magazine.
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