Missing the best and the worst days

You may have come across some articles, which go along the lines of “if you missed out on only 10 of the best days in the market then your returns would drop from 8% p.a. to 2% p.a.”. This is usually followed by the conclusion that timing markets doesn’t work and you simply have to be in the markets through thick and thin. That way you are guaranteed to benefit from those best days in the market and make good returns.

What pisses me off is that this analysis is completely one-sided. It is a half-truth. What do you think the market returns would be if you missed out on just 10 of the worst days? Yeah, I just flipped that. Obviously, missing out on the worst 10 days but still benefiting from the best days, will massively increase your portfolio’s annual returns. I have proof!

You can watch a youtube video (by Financial Choices Matter) about this – the analysis was done over an investment period of 107 years (Jan 1900 to Dec 2006) and the results are below:

As you can see, it holds true that missing out on the best days will reduce your returns. But it’s also true that avoiding the worst days massively increases the investment returns. (For clarity, the buy and hold approach turned $100 into $25,746.)

There’s also a good paper by Mebin Faber about this. I found it very interesting.
Excerpt from Meb Faber’s analysis:

He makes very interesting conclusions such as:

  1. the best and worst days tend to cluster together (volatility clustering) – the majority of both the best and worst days happen when the markets are in a down trend (below a 200 day simple moving average) -> therefore, the ride is much calmer when you’re invested during times of the market being above the 200 day simple moving average.
  2. if you miss both the best and worst days, then your annual returns are better than buy and hold.

The above analysis would suggest that market timing can indeed work and that there is HUGE value in eliminating the bad days. Investing during times when the market is above its simple 200 day moving average could eliminate 60-80% of the volatile days (both best and worst days) and then allow you to benefit from the uptrend. It would be a smooth and relatively boring ride, but the data suggests it would work better than buy and hold.

Bi den! 🙂