Most experts advocate that you should stay invested in equities for the long term (10, 20, or 30 years). Studies show that if you do that, the chances of your losing money are negligible. However, if you are not careful, long-term investing can be a suicidal strategy. First, in the case of long investment periods, the entry and exit are pre-decided.
You start buying after a few years of service, when you begin generating surpluses. You exit when you need the money—for your child’s education or marriage, or to buy an asset. If that is the case, then you might enter and exit at the wrong times. For example, if you had invested in the Dow Jones index in late October 1997, and exited now, your portfolio would have suffered a loss even though the investment was for a fairly long period of 12 years. The same would have happened between July 1959 and December 1974.
Second, stock prices are based on estimates of future earnings of companies. But it can take time for prices to reach those ‘fair’ levels. Calculations by Robert Shiller, the author of The Irrational Exuberance, show that between 1881 and 2000, the S&P 500’s average price-to-earnings (PE) ratio was 16 times. So, in the years when the PE was above or below this ‘average’, investors should have sold or bought stocks. In 1970, the S&P 500 index dropped below 16 times, the first time since 1959, and offered a ‘buy’ opportunity.
Unfortunately, the index didn’t reach its ‘fair’ value till 1986, or after a period of 16 years. And if you decided to sell S&P in 1986, when its PE was over 16 times, you would have incurred a loss as, apart from the 1987 crash, the S&P 500 remained over 16 times.
Finally, in order to make money in the long run, you need to time the markets. In reality, this is almost impossible as many investors have realised. If you miss out on the 20 best days (when an index witnessed the highest intra-day increases), you would incur a loss over 10-15 years despite the index having risen during the period.
Therefore, the best way to play the market is to forget the period that you should stay invested in equities. It could be a few months, a year, or several years. All you should do is to fix your expectations of returns, and exit as soon as you earn them. And then think about re-investing during the subsequent bear phase.
