During the bull run following the Tech Bubble, many investors were reluctant to invest in equities. More than likely, there will be many investors who will feel the same way for years to come. When left to emotions, investors are invariably always a step behind and this can really hurt portfolios because what tends to happen is that when people start to feel confident about the markets again, the markets may be ready for their next downturn. So these investors basically get into the markets at just the wrong time, and leave at just the wrong time too.
This chart shows the performance of the TSX from a random period of time. I also plotted a hypothetical GIC type investment which shows up as a straight line with a shallow slope.
When the TSX had this 14.52% correction, you can be sure many investors ran for the hills and purchased money market funds or GICs. But look what happened after the correction. The TSX came back up. Let’s plot a portfolio of an investor who was invested in the TSX and then switched to a GIC out of fear during the correction.
If the portfolio started with $10,000 (and not assuming transaction costs or management fees, etc.), than the buy and hold investor basically doubled their money. The person who switched out of fear gave up half of their potential returns with an ending amount only slightly above $15,000.
Always A Step Behind
But the real problem is that now this investor might look at this chart and say, “Yup, equity is the way to go – I’ll switch back now.” If we fast forward the chart, and the investor then switched back to the TSX his total portfolio value today might be back down to $10,000 as the TSX soon entered a bear market after the end of the above charts.
The investor is now thinking, I was right all along – should’ve stayed in GICs. And you can see how the vicious cycle can repeat.
It is important to stick to a plan. By just holding GICs the investor would be better off than constantly switching between equities and GICs at the wrong times (like many investors are inclined to do due to emotions.)
If you are going to commit to a long term investment plan, you can’t focus on the short term performance if you expose yourself to equities. As Canadian Capitalist put it, “…the higher returns from equities come from bearing the risk of holding stocks through times such as this.“