How time in the market beats timing the market

Our expectations drive our satisfaction, as much, if not more than actual outcomes.

Expectations in investing

When investing in any risk asset (any asset that isn’t cash), investors need to have a reasonable expectation of how long their investment will take to bear fruit.

This is not a question of lowering expectations; investors should always retain high but realistic expectations.

Understanding different assets and timelines

However, it’s important to understand that volatility does not always reflect risk. For instance, some investments will provide outsized returns in good times, but also provide outsized losses in down times. In those circumstances, movements are simply a magnification of market movements, both for profit and for loss. In these cases the volatility is a reflection of risk.

This is the case with the Collins St Value Fund. Our fund has outperformed the ASX during weaker markets (suffering less than 60% of the down capture in negative months), and managed to capture much of the upside in positive markets. We would argue that the true risk (the risk of permanent loss of capital) may be lower than the market, even as our returns over the long term have been higher.

Understanding what we can control (and what we can’t)

For long term investors that means building in enough buffer so that even if an investment takes longer than anticipated, the rate of return is sufficient to pay for delays.

Time in the market

Taking a five-year view won’t necessarily completely remove the volatility risk associated with investing in equity markets, but it ought to give investors sufficient time to experience most of a cycle, for the underlying business to deliver on its promise, and for markets to cotton-on to the intrinsic value of the business.

After cleaning up, we all left the kitchen to wait for the cake to bake.

I explained to my kids that the process takes 30 minutes, and no amount of wishing, prodding or supervision would change the outcome – indeed, it would lead to a worse result.

Lessons learned from baking a cake:

The payoff for patience

As the following chart illustrates, any five to seven year time frame would have seen investors reduce downside risk and the total-return volatility, regardless of whether it included the worst years since 1900.

For instance, a 3-year investment from 2007-2009 (including the GFC and one year of recovery) would have generated a -0.6% annualised return, yet a 7-year investment to the same end date would have generated almost 12% p.a.

The potential cost of mistiming the cycle

Being in the market through the cycle is essential. Indeed, being in the market (especially) when things seem most uncertain is one of the keys to outperformance.

For instance, since 2009, the ASX200 has generated a return of approximately 7.8% p.a. However, if an investor were to have missed out on just the best 1% of days, their return would have been an underwhelming 1.5% p.a.

Expected time frames and outcomes are frequently misaligned. It’s our job as investors to set reasonable expectations and position ourselves for success even when outcomes are delayed.