Terry Smith manages the Fundsmith Equity fund, which is the largest unit trust in the UK.
Smith’s strategy of investing in only a few, high quality companies for the long term has been highly successful. But there is one thing he refuses to try to do:
“There are two types of people when it comes to market timing,” says Smith. “Those who can’t do it, and those who know they can’t do it. And I know that I can’t do it.”
The ups and downs
It is quite obvious to any investor that there are good times to be in the stock market, and bad times to be in the stock market. This year has delivered a clear illustration of that.
It is quite easy to look at world markets in 2020 and conclude that they should have been avoided during February and March. It is equally simple to notice that it would have been a great idea to pile in again in April.
If you could have done that as an investor, you would have made a lot of money. You would have avoided the crash, and then enjoyed the gains in the rebound that followed.
Seeing the signs
It is even possible, with the benefit of hindsight, to think that there were clear signals that could have helped an investor to get this timing right. Going into February it was clear that the coronavirus was highly contagious, that it was potentially fatal, and that it was spreading beyond China.
It doesn’t take much to believe that it was, in fact, obvious that this was going to have a huge impact on economies and the stock market. Selling all your shares and putting the money safely in cash should actually have been a simple decision.
Equally, by the end of March, central banks and governments had started to inject huge amounts of stimulus into their economies. They were going to do “whatever it takes” to prevent a deep recession.
That should have been a clear signal that the worst was over. An investor who was really paying attention should have known that was the time to re-invest.
Don’t over-simplify the past
It is this sort of thinking that leads some investors to believe that they will be able to time market ups and downs in the future. They imagine that they will be able to tell when it is time to sell and when it is time to buy.
However, this is rarely successful. The truth is, as Smith points out, the ability of people to consistently get these decisions right is minimal to non-existent.
There are two big reasons for this. The first is that when we view markets in hindsight, we are able to dispassionately. Even just a few months removed, we can look back on what happened in February and March this year as theoretical.
Secondly, we forget what it was actually like to be investing at those times. In the middle of February, the S&P 500 was at record highs. Sentiment was positive, selling everything at that point would have been to take a highly contrarian stance.
Equally, towards the end of March, most of the world was still locked down. The global number of daily new cases of Covid-19 was starting to really accelerate. It didn’t feel like a time to be taking more risk with your money.
Either of those decisions would have been extremely hard to make. Getting both of them right would have taken enormous foresight and courage.
As Methodical Investment Management pointed out earlier this year, many investors under-estimate just how difficult this is.
“A simple calculation proves that odds are not in your favour,” they note. “The best investors don’t even have a 55% success rate in getting their investment decisions right, but let’s say for example that you have a crystal ball and are able to get the calls right 60% of the time. To get it right twice (on exit and entry), you only have a 36% chance of making the right decision (60% x 60% = 36%).”
In other words, even someone who is an investment genius has only a little more than a one-in-three chance of being correct. For ordinary mortals, the chance is really far lower than that.
And it’s worth bearing in mind that even someone like Terry Smith, who many people think is an investment genius, isn’t prepared to try.