Doing nothing is the best strategy when markets go wild

There are good reasons to do nothing when markets bounce around as they have this week. We in financial services like to point these out. For obvious reasons, we prefer our clients stay invested. But that does not mean we are wrong. Most of the time, sitting on your hands really is the best strategy.

The gyrations on Monday illustrated the first of these reasons - the crucial difference between signal and noise. This is a distinction that has become increasingly important in a post-truth age. It used to be the case that politicians and the media avoided saying things that were obviously false. Those days are gone. There is more noise than signal today.

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What is puzzling is how slow financial markets have been to recognise this. Perhaps investors just like to have something to trade on. If your investment horizon is less than a day, you might not care whether the news is fake or not. Buy the story, surf the wave, get out. For the rest of us, it feels like the truth should matter more than it does.

It is depressing how accepting we have become of the cavalier statement, the quick denial, and the subsequent down-page story highlighting the spike in trading that preceded the news. What would it take to elicit more than a cynical shrug?

Sometimes it does make sense to do something with our portfolio. With the benefit of hindsight these moments are clearer than they appear in real time. Like most people, I have been on both sides of these sliding door moments.

In March 2020, I came back from a holiday to find the FTSE 100 a third lower than it had been a month earlier. Even in the context of a global pandemic, that looked wrong. I invested in an index tracker, which rewarded me more quickly than I could have hoped.

But there are other times when I have been the frog in the saucepan, not noticing the rising temperature until I was cooked. During both the bursting of the dot.com bubble and the financial crisis, I found it all too easy to keep telling myself the bottom had been reached - until three years on I woke up to find the market had halved.

It did not matter so much to me then. I had less to lose, and I had years of working ahead of me. I am keen to avoid a repeat of those downturns today.

Declines of this magnitude are thankfully rare. They are the only occasions when it really does make sense to be out of the market. In every other case, the risks of market timing outweigh the potential rewards. Here are three more reasons why switching off your screen and enjoying the grandkids is a better strategy.

In periods of extreme volatility, the best and the worst days in the market cluster together. Even if you are lucky enough to miss the down days, you are almost certain to miss the rebounds too.

This matters because just a handful of the best days in the market account for a high proportion of the total returns from investing over time.

If you had invested £100 in the FTSE 100 index at the end of 1991, reinvesting your dividends until the end of February this year, you would have turned your initial investment into £1,500 over 34 years. If, however, you had missed just the best 10 days over that period, you would have only half as much (£750). Missing the best 20 days would have left you with £470. Leaving the best 40 days on the table would have reduced your final pot to £215. Please remember past performance is not a reliable indicator of future returns.

It is not just that you miss out on those days’ returns. You also pass up the cumulative returns on those returns. It is the magic of compounding in reverse.

In case you are thinking of letting me know, I do understand that if you had instead missed only the worst days in the market over that period, your final return would have been commensurately better. If you think you have the skill to do that, then go for it.

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The second reason to do nothing when markets bounce around is that volatility magnifies the emotional biases that can make us our own worst enemies when it comes to investing. If you have been watching the value of your portfolio slip over the past few weeks you will understand the temptation to sell to stop the pain. It is called loss aversion, and it makes cowards of us all.

The next bias to be amplified by volatility is the tendency to expect that what has just happened will continue. It is called recency bias. Herding is also accentuated by market gyrations. Under pressure, we look to follow the crowd. It all adds up to a tendency to sell low and buy back higher - the opposite of what we are trying to achieve.

The third reason to do nothing is the fact that timing the market requires not one but two decisions. We have to get out of the market, and then we have to get back in again. The first of these is relatively easy; the second is difficult. It requires us to swim against the tide, to go against the prevailing mood. What is worse, the longer you leave the decision to get back in, the harder it becomes. If you think losing money hurts, try sitting on the sidelines watching others make it.

Here is a bonus reason to do nothing. According to the new UBS Global Investment Returns Yearbook, a dollar invested in the US stock market in 1900 had grown 10-fold by the 1920s, 10-fold again by the 1950s, same again by the 1980s, once again by the turn of the millennium, since when it has done it once again. The ups and downs this month are a rounding error.

This article was originally published in The Telegraph.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.