Originally published in The Papyrus, Fall 2000. A Publication of Hermes Econometrics

Timing Doesn’t Have to Be Perfect to Beat
Buy and Hold

The most common argument against market timing is that investors will miss the best days of the market and see their returns suffer dramatically. But, before you buy this argument, you should look at the flip side - what happens if you miss the worst days? - says the Society of Asset Allocators and Fund Timers, Inc. (SAAFTI). And perhaps even more likely, what would happen if you miss both the best and the worst days?

SAAFTI compiled data on the daily rate of return for the S&P 500 for a 16-year period, from April 1984 through October 2000, and looked at what would have happened if an investor missed the best, worst and both the best and worst days. For the 16-year period, the S&P 500 average annual rate of return was 14.83%. Missing both the best and worst days would have netted an investor an average annual rate of return of more than 17.44%, exceeding buy-andhold performance. That return doesn’t vary much whether one misses the best and worst 10, 20, 30, or 40 days. “Making these statistics even more interesting is the historical pattern of best and worst days,” says Peter Mauthe, president of Trendstat Capital Management and SAAFTI board member. “The best days often occur just after a series of down days, and sometimes even in the midst of a down market. If you miss the worst days of the market, there’s a fairly high chance that you will miss the best as well. But, what this study shows is that missing the best really doesn’t matter. Unlike the best days, genuinely bad days in the market rarely happen in isolation. There is typically a pattern of nervousness in the market, a series of small losses that may be accelerating until suddenly investors as a whole turn skittish, pushing the market down to bigger loss, “ he explained.

That is where SAAFTI contends that a disciplined active investment approach can really make a difference in financial performance and risk management. Part of the reason missing the best days doesn’t matter, as long as you miss the worst days, is that the worst days are often far worse than the best days are good. Plus, there’s the impact of the mathematics of gains and losses. If you lose 20%, you have to achieve a 25% gain to return to breakeven. A 50% loss requires a 100% gain to return to breakeven. For the 16-year period SAAFTI researched, cumulative loses from just 10 bad days add up to -75.47%. Recouping those losses required a 408% return.

S&P 500 is an index and investors could not invest directly in the S&P 500 to achieve these results. However, there are a number of index funds that have proven to track the S&P 500 very closely, making this a realistic example.