In an environment of negative economic news it may be tempting to invest in cash or GICs until “things calm down” and there are signals that it is “safe” to go back into the market. A graph from the Investment Funds Institute of Canada shows that as the value of the TSX rises, the amounts invested in money markets or cash falls and as the TSX falls the amounts invested in cash rises. The TSX market bottom almost exactly matches the height of investment in money market funds. In other words we are tempted to buy when we feel good and sell when we feel bad which is the same as buying high and selling low.
Another point to consider is that if we go to cash we generally miss most of the recovery because we sit on the sidelines too long before re-entering the market. If you were to have invested in the TSX from January 1, 1976 to December 31, 2007 you would have earned an annualized return of 8.8% excluding dividends. If you had missed the 30 best days during this period of 11,688 days your annualized return would have fallen to 4.8%. According to a study by Nobel prize winner William Sharpe you would have to be right 70% of the time as a market timer to do as well as a buy and hold investor.
Once a correction or a recession begins we simply don’t know where the bottom will be or how long the correction will last. We do know that investors who stay invested benefit from 100% of the recovery!