When to invest? Timing the market vs time in the market.

When to invest? Timing the market vs time in the market.

The stock market has always been volatile, but today, investors face unprecedented challenges. With the rise of social media platforms, mobile apps and other technologies, the way we interact with each other and share information has changed dramatically and it can lead us to make rash decisions when it comes to our investments. We can hear something on the news one minute and liquidate our stock market holdings the next.

Equally, with the ability to continuously check our portfolios, we can become more paranoid and sensitive to the minute-by-minute fluctuations of our holdings. Sound familiar? The key to staying in control, and in an attempt to quell those feelings of investment anxiety, is to stop checking your investment apps and remember that “time in the market is more important than trying to time the market”.

Why are you investing?

A useful tool to consider when you are investing is to remind yourself why you are investing. Depending on your stage of life, you may well be investing your capital for a retirement that is decades away, alternatively, as someone that has already retired, your money may be invested to provide you with an immediate income. Or, you may be saving for a house deposit in a Lifetime ISA, in which case you are likely to be looking at an investment period of between 5 and 30 years.

The recurring theme of these examples is that they are long-term investments and more often than not, these investments fall under the passive investing heading - taking advantage of long-term performance to grow your capital (with minimal trades) over a long period of time. If you, or your investment manager, are doing anything else, such as timing the buy and sell points of individual shares, it is likely to fall under the active investing heading.

In summary, passive investing could be described as ‘time in the market’ or buy-and-hold investing whereas active investing could be described as ‘timing the market’ or market timing.

What is active investing?

The aim of active investing is to try to time each trade to maximise the return. These trades can include individual shares, multi-asset funds, index funds, bonds and so on. However, as a basic example, you could study the charts for a particular share and decide to buy at a notional figure of £80 per share and because of recent company news and your own share valuation exercise, you think that the stock will rise and your exit point will be £85 per share, netting you a gross profit of £5 per share or 6.25%. The first thing to note is that you have just committed to a benchmark of £80 per share and all your performance will now depend on that figure. The second point to note as with each trade comes frictional costs - these include the charges your platform makes to cover the costs of the trade when buying and selling plus the spread (the buy price is typically higher than the selling price). Essentially, the moment that you invest into a share, you will typically be in a loss-making position, albeit very small, before you even get going.

The next step of an active investing is to constantly monitor the market to time your exit point. Most platforms allow you to set what’s known as a ‘stop-loss’ and a ‘limit order’. A stop-loss simply means that you set a share price floor at which point, if the share price falls to that stop loss, you will automatically offer to sell your shares at that price and ‘stop your losses’. A limit order is the opposite, so when the price rises, once it hits the price you set, you will automatically instruct the platform to sell the shares and you can lock in your profits. The issue with these pre-determined orders is that they are binary. For example, you could set a limit order of £85 to secure your profits and the shares could fluctuate between £84.50 and £84.90 for months before some news comes long and the shares dip to £74 per share overnight and you’ve then lost all your profits and with a stop-loss order in place, your shares will have been automatically sold. The balance will then be sat in your account awaiting your next instructions, not growing at all.

If this sounds a little stressful, it’s because it is and active investing is considered to be a high-risk strategy. For this reason, the active portfolio management industry exists. They will look out for all the share growth opportunities on your behalf, time your entry and exit points and charge you fees every step of the way for the convenience. This means that an example gross return of 10% over a year that is subject to a management fee of 4% means your net growth would only be 6%. The question you need to ask is how does this return compare to that of the market as a whole?

What is passive investing?

Passive investing takes a much more long-term view of the market and is simply a case of buy-and-hold. It’s the strategy adopted by the world’s best-performing investor, Warren Buffet. As with active investing, passive investing can consist of all the usual asset types, however, the aim is to not try to jump in and out of the individual investments, but to pick a range of investments that suit you and stick with them for the long term - whether you aim is growth or income.

At the very basic end of the passive investing spectrum is what’s known as an Index Tracking Fund. These are a mixed bag of shares that reflect the makeup of an index, like the FTSE100 (the 100 largest companies in the UK). You can then choose to make regular contributions to this fund, reinvest the dividends or take the dividends as income. That’s it. It then ticks along over time and you know that you are getting an investment return that is in line with the market as a whole. The downside to an index tracking fund is that you are 100% exposed to market volatility. The benefit of an index fund is that they typically have very low management fees, often just points of a per cent.

To further reduce your exposure to risk, you could consider what’s known as a multi-asset fund. These are usually made up of a basket of shares, plus a range of bonds and other assets to provide a more balanced return over the long term and reduce the fluctuations.

Summary.

Unless you are able to predict the future, trying to time the market can be a high-risk, high-stress and high-cost investment strategy. If you are investing over the long-term (typically from 5 years to several decades), then a more measured, low-cost approach (passive investing) may offer a lower level of stress. So with this in mind, think twice before you log into your investment app and find yourself getting stressed about the value of your portfolio and ask yourself whether you are an active investor or a passive investor.

Remember, all investments are subject to financial risk, so it’s important to understand what you are doing and seek professional investment advice where appropriate.

What’s next?

Do you prefer active or passive investing? Let us know in the comments below. If you need advice on pensions and how you can invest for the future, you can get in touch with one of our advisors for independent financial advice. We offer a free initial consultation and although we are based in Tunbridge Well, we advise clients across the UK.

Don’t forget, this article offers information about financial planning and investing and should not be taken as personal advice. Remember that investments and pensions can go up and down in value, so you could get back less than you put in. Tax rules can change and the benefits depend on individual circumstances.