The Stock Market's Best Days

By Stuart J Watson | 21 May 2008

| 2 Comments

Those of you who work in the investment industry often try to convince people to invest for the long term. Of course we do it here at The Fool as well. But not all the arguments you see for sticking with your portfolio through thick and thin stand up to scrutiny.

One such argument always sets my teeth on edge. It's based on what would happen to your investment returns if you missed out on a handful on the stock market's best days. This year has already seen five days where the FTSE 100 index has risen by more than 3%. Such occasions are rare beasts, indeed there have only been 43 such days in the last 24 years. To see five in such a short space of time is unusual.

The impact of missing the best days

On the back of this though, a few investment pundits have rolled out arguments for what would happen should you miss out on these mini-bonanzas.

One article showed what would happen if you missed out on the best 40 days over the last 15 years. Had you remained fully invested, your average annual return would have been around 9%. But miss the 40 best days, and you would have lost money.

Another study went back even further, almost 40 years in fact. It showed that if you had missed just the 10 best days over this time, your average annual returns would have fallen from 7.5% to 5.6%. If you had missed the best 70 days, then you would have made a small loss, and if you had missed the 100 best days, then you would have lost two thirds of your money! As it happens, this study ignored dividends so the actual figures would be a little different.

What about costs?

There are three problems with this theory though. First of all, they ignore the costs of selling out and then buying back in again. You have broker's fees of course. These are cheaper nowadays but, prior to the Internet, costs of 1.5% for every buy and sell were not uncommon. Then you have stamp duty of 0.5% when you buy back in and the bid-offer spread, being the difference between the price you can buy at and the price you can sell.

So you could easily be looking at a 4% hit to sell and then buy back in again. Given that there have been less than 20 days in the last 24 years when the stock market has fallen by this amount in one day, a one-day sell and reinvestment plan isn't very sensible.

Who on earth invests like this?

My second gripe is that I doubt that there is anyone who invests in this fashion, selling their entire portfolio and then buying it back a day later. You might sell your portfolio if you're very gloomy about the economy or believe the stock market is extremely overvalued. But you're hardly likely to have changed your mind just one day later!

The world's unluckiest investor

Arguably the main problem with these examples is this though. Just how unlucky would you have to have been to have sold out for just 40 days in 15 years and for those 40 days to have been the best percentage gainers over that entire period?

I did try and work it out on a spreadsheet but smoke starting rising from my computer and it made a peculiar whining sound. Suffice to say, the odds of missing just these days are so astronomically tiny they are not enough worth considering.

So while I like to see people arguing for long-term investment and sticking to your guns, missing the market's best days isn't a valid argument in this regard.

Good days are like buses

While I was looking at all this data, I did notice a few things about days with big gains and big losses over the last 24 years. So, to close this piece, here are a few facts for stock market nerds like myself.

For starters, up days are slightly more common than down days. The market has risen 52.5% of the time over the last 24 years. Contrary to what you might expect though, there almost as many days with large gains as there are large falls. This is worth bearing in mind the next time you see a shock headline proclaiming something like "£50bn wiped off share prices!"

The second interesting fact is how the most volatile days tend to come along at once, just like the proverbial buses. I used a rise or fall of 3% as a cut off point and found that the vast majority of the biggest mover days came in six relatively short periods.

The data also suggests that the stock market has become more volatile recently, as many people suspect. Over half the major moving days in the last 24 years have come in the last 7, although we did recently see a period of over 4 years running to July 2007 where there were no daily moves greater than 3%.

Perhaps most interesting is how periods of major volatility have been good times to invest. We only have a few examples, so this may be a hasty conclusion, but both 1987 and 2003 turned out to be good times to put money in the market. 1998 was less successful but there were some good short-term gains to be had before the dotcom boom fizzled out. Could the volatility of 2008 be a signpost of clearer investment skies ahead? Only time will tell.

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