Timing the market vs Time in the market

How to eliminate emotional bias in the investing process

You like a company. Let’s call it Company A. It is an extremely well managed business, generating good cash-flows with reliable top management in a promising industry.

Company A currently trades at a price of 200/ share. But as per your valuation, the company should be available 25% cheaper, at say 150/ share, so you decide to wait instead.

Price goes to 210. 220. 230. And then it drops to 200. You, being a victim of FOMO, go all in at 200. And then bam. Price drops to your expected level of 150, where you book your losses and exit after seeing a 25% draw-down.

Another case is, where the price very rapidly falls to 150/ share, in testing times (Think last week of March 2020 when it was really tanking). But at that point, you’re thinking about the end of the world, as you know it and how the price “has to come down” to 140/ share and that is the time to buy.

As you can, imagine, 140 never comes. You end up missing another multi-bagger, in the process, and instead rant about it in 140 characters on the bird app.

Finding a great business is difficult task in itself. Imagine losing out on an opportunity of betting on the same, just because you wanted to buy it a little bit cheaper.

A large number of investors, who are unseasoned and fairly new investors, are highly obsessed (read: unhealthy obsession) with trying to catch the bottom and the top of the market. They want to buy at the all time low and sell at the all time high.

Well, as Vijay Kedia says, there are only two people who know the top and bottom for a market: God and Liars.

This is bias in investing. Humans, being humans, are not immune to emotional bias like this in the investing process. The option of a lower buy or higher sell price, can often be disastrous.

Let us try to cover the above example in a language we all understand: Returns

Let’s say you are able to catch the bottom, and buy Company A at 150 and it goes to, say, 1,000 in 5 years. The CAGR of your returns works out to a whopping 46%.

Now, let us say, you instead purchased at 200. The CAGR in this case? 38%.

An alpha of 8% in CAGR definitely makes catching the bottom worth it, doesn’t it?

But here’s the catch.The probability involved in you catching the bottom, is awfully low. As per a study, missing the best 25 days to invest, from 1990 to nearly 2018, would fetch you lower returns than even US Government Bonds!

And the probability of catching the best 25 days over the last 25 odd years? 1/250 i.e. 0.4%. Still worth the extra 8%? (Assuming 250 trading days in a year)

However, the effect of having that $1 invested throughout, did manage to generate an astounding amount of wealth.

Thereby, proving the fact that time in the market is more important than timing the market.

Conclusion

There’s always the famous quotes about buying when there is blood in the street and being greedy when people are scared. But the emotional bias attached with investing, often prevents us from doing the same. Instead, it is a better option to make this as non-biased and automated as possible, with the help of regular investing aka SIP (Systematic Investment Plan).

The only way to increase your time in the market, is to continue with a monthly SIP in mutual funds, through the thick and thin of the market.

The same process could work with individual stocks as well, where you buy a fixed amount or a fixed number of shares every week or month, and amass a decent corpus over time.