Time in the market is more important than timing the market
In life, they say, timing is everything. If you are in the right place at the right time, from a pauper you can become a superstar or perhaps the greatest batsman to have ever lived. Unfortunately, all these success stories that pander to this idea of ‘timing’ mask the years of hard work, discipline, and determination that lead up to the point of ‘discovery’. When you simply rely on ‘timing’ you are actually gambling and hoping that the right opportunity will come along. However, when you work towards something, then the probability of tasting success becomes even higher. The same logic applies to investing as well.
We have all seen one of those Watsapp forwards which say, ‘If you had invested in XYZ company in 2000, you would have accumulated crores by now’ or ‘If you had bought and exited last year, you would have captured the top’ or even better still, ‘If you had invested in March 2020, your portfolio would have witnessed a return of 100%’. So many ‘ifs’. Unfortunately, nobody really knows exactly where the market or investment might be heading in the short-term. Getting the market right in the short-term is like the toss of a biased coin with odds often stacked against you – ‘heads the market wins and tales you lose’.
Exhibit 1: 5 year chart of the Sensex
If you look at the five year chart of the BSE Sensex, you will see that over this time period the market has witnessed an almost equal number of ups and downs, differing only in terms of magnitude. For an individual investor to buy the market at the bottom of every cycle and then sell it at the peak of every cycle would prove to be an almost impossible task that will entail a high cost, both in terms of the losses incurred if wrong and transaction costs paid. However, if you look at the chart, you will intuitively understand that if you had invested in 2017 and simply continued to hold your investment then the outcome would be highly positive for you. Firstly, you would stand to make substantial gains and secondly, market volatility will have no impact on your overall portfolio returns. Thus, it is more important to spend time in the market and stay invested rather than time the markets and keep tempting fate. While time in the market can help you reap the entire gains made from market movements, it has another powerful benefit. It can also help you reap the benefits that come from the power of compounding.
Compounding, as you might already know, is a mathematical concept that ensures that both the principal and income generated from an investment earn interest. For example, assume you invested Rs. 100 at 10% per annum. At the end of the first year, you would have earned 10% of 100, i.e., Rs. 10 and the total accumulated amount would be Rs. 110. Now, in the second year, you will earn 10% of the original invested amount, i.e., 10% of Rs. 100 and 10% of the income generated in the first year, i.e., 10% of Rs. 10. Thus, total income earned in year 2 would be Rs. 11 and total amount accumulated would be Rs. 121. As the investment time period increases, the benefits of compounding amplify. Let’s see how compounding will work in the market.
Assume that you have invested Rs. 1,00,000 in the market with an expected return of 12%. The below chart shows the returns generated over a period of 2, 5, 10, 15, 20, 25, and 30 years.
Exhibit 2: Impact of investment time period on compounded returns
As you can see from the above chart, the longer you stay invested, the more time you give compounding to work its magic on your investments.
So, the moral of the story is, buy right (investment) and sit tight!