How much ‘time in the market’ do you need to avoid market timing?

By Paul Nixon, Head of Behavioural Finance at Momentum Investments

We all know the adage, ‘It’s not about timing the market, but time in the market’. Investing for the long run has proven to be a sensible strategy. It compensates investors with an inflation-adjusted return to grow wealth. But how long is long? And how long must we spend in the market to avoid the consequences of being a ‘market timer’?

These are critical questions for advisers to manage the expectations of their clients. And as it turns out, ‘long’ is changing. In Figure 1, every possible buy and sell data set on the JSE/FTSE All Share Index (ALSI) is set out. Buy dates are on the diagonal line and sell dates on the horizontal line. Corresponding returns for any period can quickly be seen by picking a point on the diagonal and then matching this with any sell date on the horizontal axis. The point where these lines meet is colour-coded accordingly: From dark green (returns greater than 15%) to dark red (returns below -5%).

Diagonal grey lines represent two-year holding periods for a quick view into holding period returns. On brief examination buying and selling the ‘market’ with anything less than a four-year holding period is extremely risky. This becomes clear as we count the diagonal grey lines needed to escape the red colour-coded periods. The Asian financial crisis or perhaps currency crisis from 1997 to 1998 that resulted in a contagion and rapid capital outflows from emerging markets (including South Africa) is clearly shown by the first patch of dark red.

At the same time, the Dotcom bubble was steadily inflating in the developed world and would be ready to burst in the early 2000s, affecting South African markets shortly thereafter (the second dark red patch). Investors would receive some well-deserved reprieve until the Global Financial Crisis of 2008 (once again the effects on South African markets were somewhat delayed) followed by a period of relatively flat and fluctuating markets until the COVID-19 crash of 2020 (this is shown in Figure 2 as the period is expanded).

Buying and selling with these short holding periods is a recipe for disaster causing an investor to pay a behaviour tax, which is the difference in future performance between the funds switched from (the theoretical buy-and-hold portfolio) and the funds switched to. You can read more about behaviour tax in our Understanding the great forces that rule the world white paper by clicking here.

Investors cannot control a market crisis, but they can control how they respond.

Expanding the holding period to six years (counting three diagonal grey lines) eliminates all the red colour-coded returns, but we still see a few areas of white (returns of between 0% and 5%) which any investor in risky asset classes would view as disappointing. These areas can be largely eliminated as we expand the holding period to eight years.

In fact, holding periods of longer than eight years have historically guaranteed South African equity investors a return of more than 5% and in most cases between 10% and 15%. This is at the very least an inflation-beating return. This is shown in Figure 1 by the shaded yellow triangle labelled accordingly. Figure 1 ends at 2019 to show how this is changing.

Figure 1: Monthly performance returns on the JSE/FTSE All Share Index for different holding periods (1996 – 2019)

Moving to Figure 2, the holding period required to eliminate the white return areas (0% to 5%) has shifted and so the concept of the ‘long term’ is shifting accordingly. In Figure 2, we need to count seven grey lines (14 years) to avoid any white return areas. This is shown by the much smaller yellow shaded triangle. Buying the ALSI in 2008 and selling in the COVID-19 crash would have wiped out any gains made from the sensible decision of buying the market in 2008. This is shown as the intersection point of the two red lines in Figure 2.

Figure 2: Monthly performance returns on the JSE/FTSE All Share Index for different holding periods (1996 – September 2022)

Getting a return of more than 5%, assuming the past repeats itself, now requires a far longer holding period. Many market commentators have talked about the shifting structure of the market and the above two charts are a good way of confirming this.

In closing, three key takeaways are:

1. Investors need to spend more time in the market to get an inflation-related return. Looking backward this has shifted from eight to 14 years. Importantly, this would be considering only one asset class (shares).
2. Diversification across shares, currency, and asset classes (such as fixed income and property) is the only free lunch with investing since it is an important determinant of investment returns and reaching investment goals.
3. Notice that the dark green patches tend to follow the red patches, so buying during a red patch has always been a great strategy.

Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services and registered credit provider (FSP 6406).