"The distinction between past, present, and future is only a stubbornly persistent illusion" - Albert Einstein
The cost of waiting
Last year we examined the cost of waiting to invest, and found that the potential returns forfeit could be immense. Markets usually do eventually stumble (and recover), but often the pothole comes after a mountainous ascent that is painful to behold if you’re still at base camp.
This week, we revisit the topic. What are your chances of finding a better entry point than today? Is it better to take the plunge, or phase in over a period of time? Or can you do even better by following a canny set of rules?
A textbook example
Let’s look at the performance of the FTSE 100 over the past year. From a level of 7,265 on 24 April 2017, it reached almost 7,800 before tumbling to just under 6,900 near the end of March 2018. Since then it has climbed back up to almost 7,400, in an episode that seems almost designed to evince the archetypal stock price rollercoaster.
If you’d invested in a FTSE 100 tracker at the very start of this period, your total return including dividends would have been a respectable 6.0%, before fees. On the other hand, if you’d waited for a pullback and timed it to perfection, you could have made 7.8%.
An extra 1.8% is nothing to sniff at, but it’s arguably a little bit disappointing as the very best payoff of a gamble that could have gone badly wrong: only one in five business days in the year starting from 24 April 2017 offered a “better” entry point in the form of a lower FTSE 100 price level, and the average bonus return from choosing one of those days was a deeply unsatisfactory -1.5% (yes, negative – because of the dividends foregone). Clearly, price levels aren’t everything.
More to the point, the timing needs to be absolutely spot-on: if you’d been a single day late to the nadir that came on 23 March 2018, your bonus return would have collapsed from 1.8% to 0.1%. Markets rebounded, the opportunity expired.
A day at the races
If we had to rank the days over the past year from best entry point to worst – taking into account the dividends received – we find 23 March coming in at number 1, as expected. But the very first day – 24 April 2017 – was a commendable 11th, in the top 5%. But this was just one example, and the FTSE 100 stretches back to 1986. Has it always been the case that waiting rarely pays off?
It seems so, and that shouldn’t be a surprise – markets have trended upwards over time. Naturally, earlier investments have tended to outperform as a result. In fact, when looking at all 12-month periods, the first day has also been the very best day in which to invest over 7% of the time, and it has been in the top 5% almost a third of the time.
Bit by bit
Needless to say, there have been moments when staying in cash has proved the better choice – especially when the dot-com bubble burst, and in the midst of the financial crisis. We have previously looked at whether phasing investments in over time can help avoid the worst of these downturns, and found that while this strategy can provide a smoother ride, it typically comes at the cost of lower returns.
But does phasing in make more sense if we restrict our analysis to those times when the stock market feels as if it’s a little dear? After all, these perceived peaks are the threat against which averaging in is meant to guard. There are many ways to define such moments, but a good proxy is when the FTSE 100 rises 10% above its average over the past year, which has been the case just under a fifth of the time (a statistic which itself should serve as a reminder that fresh all-time-highs are far from an aberration).
The answer seems to be broadly unchanged: a narrower spread of returns (an inter-quartile range (IQR) of 10.3% when averaging in, vs. 16.5% when investing all in one go), with a correspondingly lower median (6.3% vs. 9.3%).
Of course, the choice of 10% as the threshold was arbitrary, as was the choice of one year as the period over which to compare. It is possible to find criteria for which phased investment does seem to outperform all-in-one-go, but these criteria whittle the data down to such an extent that we’d be in danger of placing too much confidence on rare, extreme outcomes, the lessons of which are no guide to the future.
What if we change the phasing in to be rules-based, rather than at regular intervals? You might argue that a simple commitment to invest half upfront and half if and when markets fall by a certain amount would be more in line with our intuition to “buy low”.
Once again testing with the full history of the FTSE 100, it turns out that such a timing strategy works very well – except when it doesn’t. The fault lies in the “if”: there have been plenty of times when prices have simply kept on rising, and so our remaining half is never deployed. Investors hoping for a timing algorithm of this sort will always face the same dilemma: parameters set too cautiously will rarely outperform day-one investment, whilst set too aggressively the strategy rests on a handful of isolated cases. You might as well invest according to the alignment of the planets.
Investing is like having a difficult conversation: it’s best not to put it off for another day. Any strategy that attempts to beat the market by avoiding it is unlikely to succeed; stock prices have trended upwards over time, however you analyse it – with dividends paid all the while.
Regular phased investments will usually result in a worse outcome than simply putting your money to work all in one go, but they can nonetheless be a useful approach for those who’d rather not jump in at the deep end.
 In Focus – The cost of waiting, Jun 2017
 Compass Q2 2017 – Averaging-in – a smoother start, but at what cost?, Q2 2017