Ian Cowie: Try to time stock markets at your peril

Ian Cowie: Try to time stock markets at your peril
Anyone who acted on the old City adage – sell in May and stay away until St Leger's Day – should be feeling a bit foolish as the gee-gees run in the race of that name at Doncaster.

By Ian Cowie
Published: 1:21PM BST 11 Sep 2009

Never mind the first anniversary of the collapse of Lehman Brothers bank, which falls next Tuesday, marking the point at which the credit crunch turned into a global crisis. That sad event will be a good day for stock market bears to hold a picnic but the facts are already so well-rehearsed that they are the subject of a BBC TV drama.

No, from the viewpoint of an estimated 21m people in Britain who are aged over 50, next month's sharp increase in the maximum value of individual savings account (Isa) inputs is of potentially far greater significance. Unlike younger investors, these silver savers will be allowed to shelter 40pc more of their money in the Isa tax shelter from October 6.

While there is nothing we can do about the past, investment is one area where anyone who can afford to set something aside can have a go at influencing the future – at least for themselves and their families. Raising the maximum Isa investment from £7,200 to £10,200 per person will substantially boost savings placed beyond the grasp of HM Revenue and Customs (HMRC).

Unfortunately, many people are in no position to consider saving more in these difficult times. But, despite all the bad economic news, most people remain in work and many do not need to spend everything they earn.

The over-fifties are also the age group with most reason to save hard, now the end of their working careers is no longer unimaginably distant. It is estimated that nearly three quarters of investors who place the current maximum in Isas are aged over 50. If only half those in this age group invest half next month's increase in the Isa limit, that would mean an extra £16.5bn a year will be out of reach of HMRC.

Better still, the magic of compounding means the £3,000 extra that can be put in an Isa next month could be worth much more than that in years to come. For example, if the money grows at 5.5pc per annum net of charges – which is not unreasonable with long-term gross returns from shares at around 7pc a year, less annual charges of 1.5pc – then the extra £3,000 could be worth £5,124 after 10 years and £11,440 after 25.

Compounding works even better if you invest the extra £3,000 each year from now on. Again assuming 5.5pc per annum net returns, that would add £39,767 to the value of your Isas after 10 years and an eye-stretching £157,992 after a quarter of a century.

Against all that, many people may fear that this is hardly a good time to invest in shares, when the FTSE 100 has risen by more than 40pc from its low-point of 3,512 in March. They will include those who mocked long-term bulls like me, who pointed out how cheap shares were back then.

But the best summer rally since 1933, according to analysis by Deutsche Bank, is likely to have caused even the most thick-skinned bears to wind their necks in a bit. Anyone who acted on the old City adage – sell in May and stay away until St Leger's Day – should be feeling a bit foolish as the gee-gees run in the race of that name at Doncaster today.

Unfortunately, the summer's share price hikes do not diminish the awkward possibility that bears who were wrong in March may prove right today. Reasons to be fearful include the fact that the average price of FTSE shares are currently at nearly 16 times earnings, or more than double the price/earnings ratio of 7 in March.

So the sensible course of action for anyone who is going to lose sleep at night if the stock market falls – as it will, from time to time – is to stick to cash Isas, which are simply tax-free bank or building society accounts.

Those who are willing to accept higher risks in pursuit of higher rewards may take some comfort from the statistics which demonstrates that time in the market is more likely to generate profits than worrying too much about when you buy and sell. According to research by Fidelity International, £1,000 invested in the FTSE All-Share index continuously over the last 20 years would have rolled up into £4,325 by last month.

However, if you missed just the 10 best days during those two decades by not being invested when shares rose most, you would miss nearly half those gains to finish with a total return of £2,325. If you missed the two best days a year, you would have ended the two-decades a loser with only £775 to show for your original £1,000 stake.

With commendable understatement, Sanjeev Shah, manager of the Fidelity Special Situations Fund, observes: "It can be tempting during times of stock market uncertainty to delay making investment decisions or to sell existing holdings. Attempting to move in and out of the market can be a costly affair, though.

"In many cases, investors can often be better served by remaining fully invested during the entire period; enduring near-term pain but not missing out on the subsequent rebound.

"Today's low growth and low interest rate environment is good for equities. We have seen a strong rally since the low in March and while a correction of sorts is likely at some stage, I think the bull market will continue for some time and it is not too late to invest."

Yes, I know that cynics may say Mr Shah's analysis begs the Mandy Rice-Davies riposte: "He would say that, wouldn't he?"

But the figures – and this summer's extraordinary rally – demonstrate the difficulty of timing turning points in stock markets; not least because share prices tend to rise most sharply immediately after confidence hits a low-point. So, for investors with no faith in prophets, hanging on for the long term would appear to be the best way to buy a share of future profits.


http://www.telegraph.co.uk/finance/personalfinance/comment/iancowie/6168973/Ian-Cowie-Try-to-time-stock-markets-at-your-peril.html

Learn from the Worst: Market Timing - The Most Dangerous Game

Every day, millions of investors, try to discern where the market will head tomorrow, next week, or next month.

Market timing occurs when people move in and out of the stock market with the intent of taking advantage of anticipated short-term price movements.

Market timing can be

• as simple as you want it - maybe you've heard from a friend that the market is about to take off, so you invest in stocks - or
• as complex as you want it - perhaps you've developed an elaborate model that uses various economic indicators to predict which way the market will go in the next month.

Whatever way you go about it, though, it's not likely to end well, because the market is simply too complex and irrational in the short-term for anyone to correctly and reliably predict its movements.

Want proof that market timing doesn't work?

1. Research performed by Dalbar, Inc (in its 2007 Quantitative Analysis of Investor Behaviour): The firm notes that the S&P has grown an average of 11.8% per year from 1987 through 2006, an impressive gain. During this period, however, the average equity investor averaged a return of just 4.3%.

• The reason? As markets rise, the data shows that investors "pour cash" into mutual funds, and when a decline starts, a "selling frenzy" begins.
• In other words, the research shows that investors tend to do the opposite of the old stock market adage, "Buy low, sell high."

2. A few years ago, the investment research company Morningstar began tracking mutual fund performance in a new way. Normally, mutual fund returns are reported as though an investor remained invested in the fund throughout the full reporting period. A fund's three-year return, for example, is reported as the percentage increase or decrease an investor would have seen if he had been invested in the fund for the entire three previous years.

In a methodology paper ('Morningstar Investor Return'), Morningstar says it found that this "total return" percentage doesn't accurately portray how well investors in a particular fund really fare.

• The reason: While the "total return" percentage measures how a fund does over a specific period, people often don't stick with the fund for that entire period; instead, they jump in and out of it.
• And, according to Morningstar, the returns that the typical investor in a particular fund actually realizes (the "investor returns") tend to be lower than the fund's total return - implying that people pick the wrong times to jump in and out of the fund (or the market).

3. While investors themselves deserve some of the blame for this, mutual funds sometimes don't help. In its investor returns methodology paper, Morningstar states that if firms encourage short-term trading and trendy funds, or if they advertise short-term returns and promote high-risk funds, they may not be looking out for their investors' long-term interests.

• Their investors' actual returns will likely be lower than the fund's total return.
• (The fees mutual funds charge also don't help, something Bogle stresses; those costs make it so that the fund manager has to beat the market just for his client to net market-matching returns.)