Stock market uncertainty creates lots of worry for investors. Falls in share prices can
wipe millions of dollars off the value of equities overnight. This is why we often see
huge outflows of assets from retail funds as investors panic and pull their money out
en masse in an attempt to cut their losses.
However, history has shown that the most successful
investors are those that stick with their decisions for the
long term. They do not get caught up in the hype and short
term noise in the market but instead look for opportunities
during downturns.
To illustrate the possible effect of short term panic, let’s look at
the fate of two hypothetical investors: Mr Panic and Mr Calm.
The story of Mr Panic and Mr Calm
Mr Panic and Mr Calm both have USD10,000 invested in the
S&P 500. It is 1987 and the markets are performing very
well. Suddenly, on Monday 19 October 1987, markets across
the world suffer a major crash. The Black Monday decline
was the largest one-day percentage decline in stock market
history. During October 1987 the S&P 500 fell by 21.5%*.
As a result of this crash, Mr Panic and Mr Calm’s investments
are now worth USD7,850.
Mr Panic panics; he wants to cut his losses and pulls out all
his money. By doing so he ‘locks in’ this fall in value and
loses 21.5% of his investment, leaving him with USD7,850.
However he is not totally put off and keeps an eye on the
stock markets and early in 1989, when he sees the S&P 500
start to regain its value, he reinvests his money.
In contrast, Mr Calm, although unnerved by the crash,
leaves his money where it is.
By the end of 1987, despite the crash, the S&P 500 records
a total return of 105.2%. It then takes just over a year for
the S&P to return to its pre-Black Monday levels. And on the
20th anniversary of Black Monday it had returned over 700%.
Let’s look at what happens to these two investors over the
long term…
| |
Mr Panic |
Mr Calm |
| Original investment in S&P 500 |
USD10,000 |
USD10,000 |
| After Black Monday market
falls by 21.5% during October |
Redeems his investment and takes his
money ‘as cash’.
Cash value USD7,850
Total investment value USD0 |
Leaves his original investment alone
Total investment value USD7,850 |
| In April 1989 S&P reaches
pre Black Monday levels |
Reinvests his money
Total investment value USD7,850 |
Investment has now grown in value
Original investment value USD10,000
Total investment value USD10,000 |
| On 20th anniversary of Black
Monday – October 2007
S&P 500 has returned 731.7%
since April 1989 |
Total investment value USD65,288 |
Total investment value USD83,170 |
Mr Panic has lost out on investment gains of USD17,882 by taking his money away from the market.
In addition, if either of them decided to take advantage of the cheap prices of equities after Black Monday and
invested an extra USD1,000 during October 1987, that USD1,000 would now be worth approximately USD8,337.
Of course this is a simplified and hypothetical example and does not attempt to explain all possible stock market
scenarios or take into account fees or expenses. Investing in the stock market carries risk and investors may not get
back their original investment. |
Time in the markets not timing the markets
In theory the perfect investment strategy would be to leave the markets when prices are high and re-invest when prices are
low. But in practice this strategy seldom works as market falls and rises are notoriously difficult to predict.
Many experts agree that if you are investing for the long term it is ‘time in the market, not timing the markets’ that can
deliver superior returns. While there are no guarantees, investors are better off staying calm, resisting the temptation to leave
the markets and to sit out the fluctuations. Indeed, some investors may even see downfalls as buying opportunities.
*All data taken from Standard and Poors. Data gross of fees and calculated on a bid-bid basis in US dollars.
2008