Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Tuesday, September 15, 2009

The Best of Times and the Worst of Times

We often mention how difficult it is to time the market and recommend that you should stay invested when the market tanks. That advice, of course, assumes you have a well diversified portfolio tuned to your risk tolerance and that you are invested in low-cost high quality investment vehicles. If not, some adjustment may well be warranted.

Advisors often talk of the importance of being “in the market” when it rallies and how just a few good market days can make a big difference. A recent Morningstar® article by Invesco Aim (“Rethinking Risk: The Tale of 10 Days”, 07-16-09) looked at the best and worst days of the last 81 years to see how important it is to be “in the market”.

According to the article, “the S&P 500 Index’s 10 best performing days over 81 years (from Jan. 3, 1928, to March 31st, 2009) – yielded an average daily return of
11.68%.” The worst 10 performing days over the same period yielded an average daily return of -10.84%.

On the surface, it appears that since the average return for the best 10 days is better than the average decline for the 10 worst days, staying “in the market” would automatically make you a winner.

However, the article goes on to say that a buy and hold strategy for the entire 81 years would turn a $1 investment into $45.18 (i.e., being in the market during both the 10 best and 10 worst days). If you happened to miss just the 10 best days over the 81 years, your $1 investment would have returned just $14.99. If you had missed just the 10 worst days, you would have earned $143.47 on your $1 investments. And, if you missed the 10 best and 10 worst days, your $1 would have grown to $47.59.

Since it’s very difficult, if not impossible, to identify in advance either a “best” or a “worst” day, it’s basically unrealistic to try to avoid all the worst days in order to maximize your return. There is evidence, however, that the “best” and “worst” days often happen close to each other.

Therefore, although the article didn’t say so, one could argue, that it makes sense to stay the course during market crashes. Why so? It usually takes severe market downturns (“worst” days) to motivate investors to sell all their equities. Since the “best” and “worst” days are often bunched together, pulling out after one or two really bad (possibly “worst”) days could likely cause you to miss a coming “best” day.

The article notes the futility of trying to time the best and worst days and the impact losses can have on your portfolio. A 10% loss requires and 11% gain to break even. A 25% loss requires a 34% gain to break even and a 50% loss requires a 100% gain to break even.

If a market crash happens at the wrong time, you may not be able to achieve your goals. Therefore, the article says, you need to: “Approach your investments with an aim to reduce risk, not maximize returns.” You need to be sure that you take on no more risk than necessary to achieve your objectives. Doing that is no easy task. We strongly suggest you seek out professional help, so that you improve your odds of achieving the “best of times”.


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