Why diversification and ‘time in the market’ can matter

Why diversification and ‘time in the market’ can matter

Periods of stock market volatility can be unsettling but dipping in and out to avoid any falls, could prove to be a costly mistake.

The reality is that there is rarely a shortage of concerns when it comes to investment markets. Brexit, trade wars, the rise of populism – and those are just the current ones, can and do, impact how markets behave.

But difficult as it might be, sitting tight and doing nothing can often be the best course of action when markets turn turbulent.

This is because investors who delay making investments in the hope that prices will fall further, or who sell in the hope that they will be able to buy again at the bottom of the cycle, risk missing out on some of the potentially best gains.

Past performance should not be viewed as a guide to future returns. But to illustrate the potential benefits of thinking long-term, if an investor put $1,000 into the MSCI World Index 40 years ago, they would since have seen that lump sum grow to $34,527, equivalent to an annualised total return of 9.3%, as at end December 2018.*

However, if they’d missed just five of the best days over that four-decade period, their annualised return would have been 8.3%, leaving them with a far lower $24,060.

And if they had missed the 30 best days, they would have endured an even more dramatic impact on their returns, accumulating just $8,916 after 40 years, equivalent to an annualised total return of 5.6%.

Regional variations

The difference in performance between remaining invested and missing some of the best days can be even more pronounced when looking at specific regions.

For instance, if an investor had put $1,000 into the MSCI US Index 40 years ago, their investment would currently be worth $53,995, an annualised total return of 10.5%.

Missing 20 of the best days would see the value of their investment dwindle to just $16,009, a total annualised return of 7.2%, while missing 30 of the best days would mean their investment would have grown to only $10,320.

Similarly, if an investor had put $1,000 into the MSCI Europe Index 40 years ago, and remained invested the whole time, they’d have achieved an annual return of 9.2% and have $33,466. If they missed the best 30 days, their annualised return would be just 4.4%, and their investment would be worth $5,655, some $27,811 less than if they’d stayed put.

The importance of staying invested

It’s extremely difficult for any investor to predict which way markets are going to move next, certainly with any consistency, but as the numbers highlight missing just a few of the best days can significantly impact total returns.

Remaining invested over the long term will hopefully give any investments, which do fall in value when markets are volatile, plenty of time to recover. It also means trading costs are kept to a minimum because you won’t be buying and selling frequently.

It’s important to remember too that if you are investing regularly, periods of turbulence may work to your advantage, as you’ll be buying more shares when prices are low and less when they cost more. This can help smooth out your returns over the long term, although of course there are no guarantees and there’s still the risk you could get back less than you put in.

Thinking long term and staying diversified

Investing is a long-term endeavour and the more time you give your portfolio, the greater the chance it has of delivering positive returns and the better it can harness the power of compounding. Therefore, we believe the best way to tackle market volatility is to be prepared for it. This means maintaining a well-diversified portfolio, where your money is spread across a wide variety of different investments including cash, bonds, equites and property.

AXA Investment Managers, Equity Strategist, Varun Ghotgalkar, says: “By maintaining a properly diversified portfolio, it means investors are reducing their risk exposure to any one investment - after all, the same asset class, or indeed region, is unlikely to win out every year.

“The next time markets take a dip, which they invariably will, investors may do well to remember that these setbacks are often temporary, and that it is time in spent the market, with a suitably diversified portfolio that matters - not timing the market.”

Source: Bloomberg, Data stream and AXA-IM Research; Note: All calculations done using MSCI indices over the last 40 years ending December 2018

*All performance data source: Bloomberg, Data stream and AXA-IM Research. All calculations done using MSCI indices over the last 40 years ending December 2018

 

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