Equities continue to be one of the best asset classes in which to grow wealth, but that’s not without market fluctuations. With significant volatility over recent times, it is worthwhile to remember the importance of staying invested. Here are some reasons why:
Trying to time the markets can be costly. During market pullbacks, some investors may feel inclined to sell investments for fear of a greater loss. However, this can create two issues — selling at low
prices and the inevitable need to re-enter the markets. Market timing is difficult; perhaps one of the most convincing reasons being that the biggest up and down days have historically clustered together. The chart shows the impact of missing the best performing months of the Composite Total Return Index over a 30-year period. By staying invested, a notional investment of $1,000 would have grown to $12,693. By missing the five best months, this would fall to $7,503. And, it’s not just about timing: Selling and rebuying can potentially create a costly tax situation in certain accounts or forego dividend income.
Time reduces the volatility of returns. As history has shown, negative market performance smooths out as an investor’s time horizon increases. Since 1992, the likelihood of the Composite
Total Return Index experiencing a negative monthly return is 38 percent. This drops to 13
percent over a three-year rolling holding period, and 0 percent over seven-year rolling
holding periods and beyond.
Staying invested can take advantage of compounding over time. Often, one of the most important variables for how you’ll do as an investor is how long you are able to stay invested. This is because
of the impact that compounding can have over time. Perhaps you’ve heard of the trick question: “Would you rather have $10,000 per day for 30 days or a penny that doubled in value every day for 30 days?”
Choosing the doubling penny, due to the power of compounding,*would yield about $5 million, compared to only $300,000 by choosing $10,000 per day.
Compounding growth is often called the eighth wonder of the world because it possesses significant powers, like
turning a penny into $5 million. In the words of renowned investor Charlie Munger, business partner to Warren Buffett, “the first rule of compounding is to never interrupt it unnecessarily.” *Of course, it is acknowledged that a compounded rate of return of 100% is unrealistic.