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Do you have the patience to buy and hold?

14052018 timing the market

Do you have the patience to buy and hold?

One of the most common investment adages one hears is that “time in the market beats timing the market,” particularly when it comes to passive index investing. This advice is predicated on buying and holding – over a long period of time, the vicissitudes of the market wash out, and therefore you don’t have to worry about the initial price you pay for an index as historically, equities have always gone up over time.

I was recently looking at the historical data of the S&P 500 – which by the way, returned an impressive 9.7 per cent annualised in the 90 years since 1927 – and decided to put this piece of advice to the test.

But before we proceed, let’s quickly address two obvious problems. Firstly, no one has a 90-year investment horizon – not even Buffett, who started investing at the age of 11. And secondly, most investors have no trouble buying and selling, but have a hard time holding on due to a variety of behavioural biases that I won’t touch on here. With that out of the way, have a look at the chart below:

Screen Shot 2018-05-11 at 11.47.08 am

Source: Bloomberg and R. Shiller for P/E; A. Damodaran for S&P 500 total return since 1927

This chart shows the 10-year annualised returns of the S&P 500 over each of the 10-year periods between 1927 and 2007, plotted against the starting P/E ratio of the index in each period. What is clearly evident is that over 10-year investment horizons, the initial price you pay has a material impact on your annualised return at the end of those 10 years, especially at the extremes (very high and very low P/Es). The red dotted line is the current P/E ratio of the S&P 500.

What if we extend our investment horizon further?

Screen Shot 2018-05-11 at 11.47.54 am


At 20 years, the correlation between annualised returns and the initial P/E ratio are similar to the 10-year horizon, but at least there are no negative-returning 20-year periods since 1927. This means that initial overpayment, even for a market index, will more likely than not be detrimental to your investment returns even if you held on for 20 years. It is only at 30 years, below, that the correlation between price and return falls away. That is a very long time – unrealistically long for many investors either due to age or other unforeseen factors, even if they are perfectly rational humans.

Screen Shot 2018-05-11 at 11.48.26 am

This doesn’t mean that everyone should start trying to time the market. What it does mean is that when market prices are elevated as they are today, investors ought to pay more attention to protecting against the downside than chasing returns with a “buy-and-hold” mentality and a “long” investment horizon. Because ultimately, do you have the patience to wait three decades?

One of the most common investment adages one hears is that “time in the market beats timing the market,” Daniel puts this to the test. Click To Tweet

Daniel Wu is a Research Analyst at Montgomery Global Investment Management. Prior to joining Montgomery in June 2016, Daniel was an analyst in the investment banking divisions of UBS and Goldman Sachs, where he covered the Infrastructure, Utilities, Technology and Media sectors.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Hi Daniel

    Sequencing risk is something that should be on the minds of all investors at this stage of the cycle as valuations for every asset class look stretched.

    Timing is everything but difficult to achieve as markets can be irrational for extended periods of time and the latter stages of a bull market can produce some exceptional returns. Whilst cash can be a drag when markets are rising , it provides opportunities to acquire good businesses at cheap prices when there is blood on the streets – investors should be prepared for and welcome volatility. Active Fund Managers that presently have large cash weightings do so for capital preservation and also to act quickly when good buying opportunities arise .Paying a Fund Manager fees to hold cash is no fun , especially when cash returns are so low ,but it’s part of the strategy the Fund Manager employs to outperform the Index which the Fund is benchmarked against. The overall return of the Fund is what really matters – if that’s acceptable then the cash weighting is irrelevant. For Investors that worry about timing and sequencing risks, then dollar cost averaging may be a safe way to go.

  2. “therefore you don’t have to worry about the initial price you pay for an index as historically, equities have always gone up over time. ”

    And that’s the problem with property, because property investors in the big cities say “property only goes up” and “property has always gone up over time” (we’re not talking about those people in mining towns who have been absolutely smashed).

    The idea of buying an index is analogous to the typical “mum and dad” investor psychology of buying any run of the mill house in Sydney or Melbourne within a few kms of the city in the ‘blue chip’ suburbs, it’s no different.

  3. lakun agrawal

    Hi Daniel & Roger

    A lot of your recent articles talk about elevated prices , not seeing value in the market, holding large cash balances and protecting the downside.

    As an investor I feel I can do that myself, by simply holding onto my cash rather than give it to an active fund manager to hold cash on my behalf.

    Of course I wouldn’t want my fund manager to invest in stocks if there’s no value but equally I don’t want to pay someone to hold a large amount of cash for me (and charge me fees) when I can do that myself.

    Is there a solution to this conundrum in the current environment of inflated prices?

    • Phil Crossan

      You could allocate funds to a manager that is always fully invested, and you could invest more, or redeem, based on how much cash you want to hold.

      The data unfortunately indicates that on average investors don’t do a good job of timing when to redeem and when to invest more.

      As a results, investors on average do worse than the funds they are invested in.

  4. andrew ronan

    Hi Daniel, I just wonder can you even compare the current P/E ratios with historical P/E ratios due to all the buy backs of recent times due to very cheap money and without the buy backs what would current P/E ratios be? Also we seem to be going through the bottom of a long term interest rate cycle and it would be very interesting to see what would happen to current P/E ratios if we applied a long term average interest rate to current corporate debt, And if corporate debt is at very high levels currently with interest rates moving up after a very long period of them dropping, it just seems that P/E ratios of today could be based on very different calculations to historic periods.
    Another significant factor could be the way earnings are calculated today in comparison to historic methods and from what I can gather, today’s methods are somewhat fast and loose with the facts ( words like creative accounting come to mind) and in some cases bordering on outright fraud, it would be very interesting to see someone knowledgeable on the methods apply historic methods to current earnings and then see what P/E ratios are produced
    All these factors added up would produce some eye opening current P/E ratios and maybe the you are here line might go up a few notches.

  5. Hi Daniel,
    What would be interesting is the following exercise:
    Do exactly the same graphs but separate into industries / sectors-
    I think you’ll find that some industries e.g. health, small caps etc may have higher P/E’s but produce better long term returns than the whole index.
    I find that using index funds to pick the industries (on a yearly basis) provides significantly more reward for the outlay in risk.

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