The Upside of Fear, Revisited

It seems our argument in last week’s post against trying to time the apocalypse did not entirely convince everyone. So, let us ask a simpler question: should we sell when markets look toppy? Sitting safely on the sidelines, letting prices fall and buying back our shares for less sounds wonderful in theory. But what if markets rise? Buying back at a higher price means accepting that we were wrong. The longer markets continue to go up, the more expensive that admission becomes and the harder it is to make.

The other challenge is that long-term investing relies on allowing reinvested returns to compound. Interrupting that process can be costly, and the numbers are quite sobering. An analysis of the S&P 500 from 1990 to 2019 showed annualised growth of 7.7% for an investor who stayed fully invested. In a hypothetical calculation, missing the best trading day of each year reduced that to 3.9%, and missing the best two days of each year brought it down to 0.8%.

Of course, missing the worst days could also help enormously. Unfortunately, markets don’t announce those in advance. Nor do they wait for the headlines to improve before recovering. Even professional traders struggle to get the timing right. But they manage losses and seek measurable advantages across many trades. That’s a very different proposition from staking years of compounding on a feeling that the markets look expensive.

Trying to avoid every market setback is like leaving the motorway whenever you suspect a traffic jam. The detour only helps if it gets you there sooner.