Some people believe that timing the market and ‘banking your gains’ is a good investment strategy, as opposed to staying in the market for the longer term. We disagree. Here’s why it pays to focus on long-term gains.
One of the only certainties when it comes to investing is that market prices will fluctuate. Volatility in investment markets is to be expected, and reflects the wider price moves of markets both upwards and downwards. We are strong advocates of using the power of diversification to help combat market volatility.
Most investors tend only to think of the downwards movements in markets when considering market volatility – that’s easy to understand given it results in the value of your investment portfolio falling. However, of course, market volatility also refers to upwards movements.
Steer clear of banking your gains
One of the most common misconceptions in investing is the idea that an investor should sell their investments when they’ve made a gain, and then buy the investments back at a later point. While this sounds like common sense, trying to time rising markets is often just as bad a mistake as trying to time markets when they’re falling.
History tells us that ‘banking your gains’ in this way can actually damage your long-term investment returns rather than improve them.
To demonstrate this, we’ve looked at an example of investing in the FTSE All Share, the widest measure of the UK equity stock index since 1990. In the first case, we’ve assumed an investor remained invested in the market through both positive and negative market movements. Over 1990-2016 the return was 8.6% per annum.
In the second case, we’ve allowed the investor to ‘bank their gains’ each year, once they’ve made a return matching the average year (i.e. 8% market return). They then hold their investments in cash for the rest of the calendar year, before re-investing in the market at the beginning of the next year.
Annual returns for remaining invested vs banking gains, 1990-2016
Patience is a virtue
What we see is that by banking gains, the investor limits their exposure to upward movements in the market, while still exposing themselves to downward movements.
Furthermore, the investor has ignored the effects of compound interest, and the dividends that they may have received from the index through the rest of the year – which can be significant considering the current dividend yield of the FTSE All-Share is 3.67%.
The result is dramatic. Over the long term, by banking gains when the investor reaches a +8% return each year and reinvesting at the start of the next year, they would have achieved an annualised return of just over half of the return that could have been achieved if they had remained in the stock market.
It pays to focus on your goals
By focusing on your long-term objectives or goals, you can benefit from ignoring short-term market movements, whether positive or negative. Periods of volatile performance in markets can be unnerving for all investors, especially those worried that the market can’t rise any further or may fall from here, but staying invested is typically the best way to get the best long-term returns.
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past and future performance indicators are not a reliable indicator of future performance.