I’ve recently seen an old chart making the rounds again. This is a chart many advisors bring out when markets start getting choppy. Advisors use this chart to prevent their clients from selling stocks when volatility picks up and clients start getting nervous (like this past October for example).
While I agree that emotional investors tend to make very poor decisions that end up costing them a lot of money, the chart commonly used to try and make that point is one of the most misleading charts in all of finance. I’m embarrassed to say I also used to show it.
Without further adieu, I present the most misleading chart in finance…
The chart shows the hypothetical portfolio value of $10,000 invested in the S&P 500 and held for twenty years. That value is then compared to hypothetical portfolio values if just the 10, 20, 30 and 40 best days of the entire 20-year period were missed.
The purpose is to illustrate the harm you can do to your returns and, therefore, portfolio value if you try to time the market and miss just a few days. It is used to prevent people from selling stocks when they start getting nervous. Can you see why this is the most misleading chart in all of finance? I’ll tell you…
Because even the worst market timer in the world would not miss ONLY those best days without missing any other days! What are the chances that someone would happen to miss ONLY the absolute 10 best days in a 20-year period? It’s a useless assumption and completely unrealistic.
In reality, the best days in the market are usually surrounded by the worst days. So chances are that if you were out of the market during the best days you also probably missed some of the worst days as well! And THAT greatly improves your returns. Here’s a chart showing all the daily returns for the 20-year period in question…
It’s very clear to see that the best and worst days clump together. It’s almost like a wave where the positive and negative amplitudes are equal. But more than that, most of the best and worst days occur DURING bear markets! That’s because volatility is higher in bear markets due to greater uncertainty. This uncertainty amplifies the daily swings in price.
The fact that negative returns have a larger impact than equally positive returns makes it even more important to miss the worst days. After all, a 50% gain following a 50% loss still results in a 25% net loss (i.e. 50% loss on $100 = $50 while 50% gain on $50 = $75 to produce a $25 (25%) loss). We see this impact in the chart below that shows the hypothetical portfolio values if you were to miss the worst 10, 20, 30 and 40 days…
So, again, it’s very unlikely an investor would miss only the best days while being invested on the worst days. So I reran the data assuming the investor misses both the best and worst 10 days, 20 days, 30 days, and 40 days. See the results below:
Although it’s also not realistic to expect to avoid only the best and worst 10, 20, 30, or 40 days, it is far more realistic than the original version I see so many advisors using.
Past performance is not a guarantee of future results. Not intended as investment advice but general education.
Data from third-party sources is believed to be reliable but not guaranteed.
