Andrew Page
Andrew Page

A lot of people spend considerable time and energy in trying to determine whether the market has bottomed or has further to fall. While we can attempt to calculate reasonable and objective estimates, the fact is no one can ever be sure, not even the most qualified and experienced professional. Indeed a focus on short term market movement can be downright hazardous and can force us to lose sight of our long term investment goals.

Perhaps a better question is whether or not there are attractive investment opportunities at present. That is, are there companies which are trading at attractive valuations with above average earnings and dividend growth prospects? Moreover, what are the risks associated with such prospects?

I believe the next 12 months will present us with extremely attractive (and rare) long term investment opportunities. An objective fundamental appraisal will help demonstrate this, and lessons from history allow for some optimism, but there is no hiding from the fact that the current apprehension and uncertainty over the global economic prospects mean that there are nonetheless real and significant risks involved. After all, no matter how fundamentally attractive a company may appear it is still entirely possible that further unforeseen negatives act to drive share prices lower still. That is, we may well demonstrate that value exists, but even greater value could be seen in the future!

As a long term income investor the prospect of short term capital loss, although unwelcome, is not a source of great concern. Indeed, to assume that an asset as volatile as a share will only ever go up immediately after purchase is neither realistic nor helpful. This is why you should only ever invest in the share market with capital that you are not likely to need in the next few years.

It is remarkable how much risk is lessened by time. This is something that seems intuitive, and can also be demonstrated using historical data. Consider the following chart; it shows the variation in annualized returns for various time periods over the past 30 years. (Every 1, 2, 5, 10 and 20 year holding period since 1979 was examined, with purchases and sales being made at the start of each calendar year).

click chart for more detail
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If you look at the average annualized returns for all timeframes, they are essentially the same (around 12%) But these averages ignore the fact that there is considerably more variability in returns for shorter holding periods. With an investment timeframe of just 1 year, annual returns ranged between -40.4% and 66.8%. That represents a significant degree of risk, and anyone planning on holding shares for just one year must be prepared for the possibility of substantial loss.

The important thing to note is that the variability in returns drops significantly with time. Indeed, not one single 5 year investment period since 1979 has resulted in a loss, and the range of returns was considerably smaller. Remember too that we have considered every 5 year period since 1979 (as measured from the start of each calendar year), and as such have included periods such as the 1987 crash, a number of recessions, the Asian Financial Crisis, the tech wreck and the latest Global Financial Crisis.

The variation in returns continues to decline the longer the holding period, which makes a lot of sense. Those with a longer investment horizon not only have more time to recover from market falls, but are also more likely to experience periods of strong growth. When you invest for a short amount of time, you may well experience phenomenal growth, but you face considerable risk of taking a loss. In fact, almost a third of all 1 year investment periods since 1979 resulted in a loss.

Investment Period Profitable Periods Unprofitable periods Proportion of Unprofitable periods
1 year 20 9 31.0%
2 year 25 3 10.7%
5 year 25 0 0.0%
10 year 20 0 0.0%
20 year 10 0 0.0%

This is why it is so dangerous for people close to retirement to switch all their capital into shares. Retirees simply cannot risk losing substantial amounts of capital at a time when they are depending on that capital to support themselves - something that many unfortunate Australians have found out the hard way. (It is of course a different story if they had invested heavily into shares 10 years prior to retirement – even with the recent crash).

So from the long term investors point of view, a preoccupation with short term market swings is a distraction at best, and downright dangerous at worst. The question of the market bottom may be important for short term speculators, but investors would do best to ignore such musings. Instead of asking whether or not it is time to invest in the market, you should really be asking if you have enough time to be invested in the market. As the old saying goes; it is not about timing the market, it’s about time in the market.

Make the markets work for you

Andrew Page