Keeping your money invested could be a better long-term strategy than trying to second-guess the stock market
Making money from the stock market is simple, right? All you need to do is ‘time the market’. That means buying stocks low and selling them high.
Unfortunately, it’s not that easy. Even experienced fund managers don’t get it right often, so what chance is there for novice investors?
Not much – in fact so little that there is an old investment saying which suggests “time in the market, not timing the market” is key. It means that keeping your money invested is a better long-term strategy than trying to predict or guess future stock market movements.
Experienced Personal Finance expert Emma Lunn takes a look at what you can do to help get the timing right for your investments.
What do you know about Pound Cost Averaging?
Many investors use a strategy called ‘pound cost averaging’ to invest in the stock market.
Basically, this means drip-feeding money into the market, rather than investing a lump sum in one go. It especially suits people who invest out of their monthly income, rather than from a cash lump sum.
By investing a monthly amount into your investment portfolio you can ride out the highs and lows of the market. When share prices go up, the value of your stocks rise, and when they go down your next contribution buys more.
While this strategy doesn’t promise a profit or protect against losses from a market downturn, it can help lower the average cost of fund purchases, plus you don’t have to worry about buying at the ‘right’ time.
Pound Cost Averaging in action
Let’s say you decided to invest £500 a month. If the share price of your chosen stock is £10 in the first month, you can buy 50 shares. If the share price falls to £5 the next month, your £500 will buy 100 shares. This means you will have 150 in total after two months.
But if you’d invested your £1,000 all in one go all on day one, you’d just have 100 shares (£1,000 divided by the initial share price of £10).
In a volatile market, the average price per share can work out lower when you invest regularly; in this case the price per share is £6.66 if you invest monthly, versus £10 if you invest it all on day one.
Why time, not timing, can be key
But not all investors will be keen on pound cost averaging and will instead attempt to ‘time’ the market instead. This means buying when the market is down, and selling when it’s come back up. But this can be a risky strategy.
An example by investment company Vanguard shows the cost of getting it wrong . It looked at the FTSE All-Share Index between January 1986 and December 2016. Investors who tried to time the market but judged it incorrectly and missed the 10 best days over that period would have lost half their potential return.
If you want to make money from stocks and shares, you need to think long-term. Over the long-term (10 years or more) the stock market generally tends to deliver returns.
In the short-term, equity markets can be quite volatile due to a number of factors (such as political instability, currency fluctuations, news events, and investor confidence) and can experience sharp falls or gains in stock prices.
Second-guessing those short-term moves can be a tricky, and potentially expensive, game. If you get it right, it can be lucrative but in most cases, in my opinion, investing for a long time will yield better results than holding out for the ‘right’ time to invest.
Getting it right for your money
If it was possible to be right every time, then there would be a lot more investor multi-millionaires out there. Given that the vast majority of everyday investors aren’t living the high life it stands to reason there’s a hefty element of luck involved in investing as well as knowledge and skill.
As is often the case with investing the best advice is balance and measurement. It is probably wise to have a balance of investments in your portfolio some of which benefit from the ‘time in the market’ approach, alongside one or two which rely on ‘timing the market’, if you are comfortable with this strategy.
Either way, it pays to keep an eye on what your money is doing, and regularly reviewing investments to make sure they are working the way you want them to. If you are ever in doubt, speak to a financial adviser.