What happens when you miss the worst market days?

On July 6, we showed how watching business channels can be injurious to investor health. The moot point was that when television tries to explain every small move that the market makes, it’s unlikely you’ll make money because chances are, you’ll be persuaded to constantly change your portfolio and lose out on the best days.

Some readers responded to this article saying they wanted to know what happens when an investor stays away on the worst days. We ran the numbers, and here’s the story:

If you had invested Rs100 in the Sensex stocks on January 1, 2001, and held on till July 4, 2011, — but stayed away from the 25 worst days in between, your investment would be worth around Rs2,202, or a return of 34% per year before taxes and charges.

That’s a nearly 4.6 times return compared with what you would have by simply buying and holding (`476).

But, as in life, investing is not that simple, especially because the biggest gains and losses follow each other. Here’s how:
On September 17, 2001, the Sensex fell by 5.3%, rebounding 3.8% the next day.

On May 17, 2004, it lost nearly 11%, and gained a little over 8% the next day.

On January 22, 2008, it’s the same story: lost a little under 5%, and rose a little more than that the next day.

On October 10, 2008, the market lost 7.1%. And on October 13, which was the next trading day, it gained 7.4%.

So it’s impossible to figure out market direction and be able to stay out on bad days.

Also, investors are victims of what’s called the ‘recency effect’ — that is, the tendency to give weightage to events that have taken place recently.

So if a market falls, it is expected to continue to fall, and vice versa.
Taking that into consideration, let’s do a more fair calculation and see what happens. Let us say you had invested Rs100 in the Sensex stocks on January 1, 2001, and held on till July 4, 2011.
In between, you missed the 25 best days and 25 worst days by actively managing your investments.

What happens? Your returns would be around Rs478, without taking into account taxes and other charges.

And how much did you make when you invested Rs100 and just stayed put? Rs476.

So whether you actively manage your investments or just follow a buy and hold strategy, over the long term, things even out.

A study by US firm Invesco in 2009, which was referred to in the earlier article, also showed the same thing. If you had invested $1 in the S&P 500, a stock market index in the United States, and stayed invested you would get $45.2 by 2009. If you had missed the 10 best and 10 worst days, you would have been a little better at $47.6.

The summary, therefore, is the biggest gains in the stock market could get cancelled by the biggest losses.

And in the end it’s those little daily gains that gradually add up, help build wealth.

And that’s why it is important to stay invested rather than time the market.

So keep on the television channel if you are addicted, but remember, your investments have the best chance in a ‘buy and forget’ approach — underscored by the redoubtable Warren Buffett.

Michael J Mauboussin, chief investment strategist at Legg Masson Mutual Fund, one of the biggest mutual funds in the world, explains it well in More Than You Know - Finding Financial Wisdom in Unconventional Places: “The press sounds a lot like a split-brain patient making up a cause for an effect, and we investors lap it up because the link satisfies a very basic need (of stories)... The point here is not that cause and effect don’t exist but rather that not every effect has a proportionate cause. As humans like to identify a cause for every effect, this concept is difficult to internalise.”

The writer can be reached at chandniburman@yahoo.com