A sure way to make nothing
A sure way to make nothing
Now might not be the time to panic, but why not ride out this period of volatility with a little cash on the sidelines? Here’s some food for thought.
In his Little Book of Value Investing, Christopher Browne points to a US study by Sanford Bernstein & Company which ‘showed that from 1926 to 1993, the returns in the best 60 months, or 7% of the time, averaged 11%. The rest of the months, or 93% of the time, returns only measured around 1/100 of 1%’.
| Month | All Ords return |
|---|---|
| Dec 1971 | 18.2% |
| Jan 1975 | 17.4% |
| Oct 1974 | 17.2% |
| Jan 1980 | 17.2% |
| Apr 1983 | 15.4% |
| Jul 1987 | 15.1% |
| Apr 1968 | 14.1% |
| Mar 1988 | 13.2% |
| May 1980 | 12.4% |
| Jan 1974 | 12.1% |
I ran some numbers on the Australian market and the contrast is similarly striking. From February 1960 to February 2008, the monthly return from the All Ordinaries Index averaged 0.70%. But in the best 40 months, or just 7% of the total, the monthly return averaged 10.4%. In the remainder, it averaged zero.
Short sharp bursts
Most of the stockmarket’s returns come in short, sharp bursts and if you miss them you’ll do tremendous damage to your long-term returns. Miss the best 7% of months and you’ll end up with zero.
In Browne’s words, ‘the reality is (and it’s been proven) that the biggest portions of investment returns come from short periods of time but trying to identify those periods and coordinate stock purchases with them is almost impossible’.
Many value investors, such as Walter Schloss, Peter Lynch and the aforementioned Christopher Browne, have generated incredible returns while remaining fully invested 100% of the time. Others, like Charlie Munger and Warren Buffett, have been equally successful keeping some cash on the sidelines and pouncing in times of distress. But the one way to ensure mediocre results is to be fully invested at the top and sitting on a pile of cash at the bottom.
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Comments
I admit I haven't looked into the details but isn't the analysis too simplistic?
1. all shares don't move in line with the index - just because you miss a 10.4% gain in the index one day (or month) doesn't mean that the shares in your portfolio won't rise 10.4% the next day (or month) when the index doesn't move.
2. gains aren't locked in. the index may gain 20% in one month and lose 19% the next. if you missed both months you only missed a 1% gain.
You're dead right that it's too simplistic. As Gareth (a colleague of mine at The intelligent Investor) pointed out, you could also make the same argument about missing the down months. The returns in the worst 40 months averaged –9.8%, and if you missed those you would have doubled the average monthly return from 0.70% to 1.49%.
The point I was trying to make is that there's no point waiting until the market has tumbled and then deciding it's time to sell (January 2008 was the 8th worst month in the 576 months in my data set). This 'I'll just wait out this period of volatility' strategy locks in the bad returns and leaves you at serious risk of missing out on the good.
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