If This Chart Tells You Anything, It’s That Some Charts Are Misleading.

If This Chart Tells You Anything, It’s That Some Charts Are Misleading.
Stéphane Renevier, CFA

over 1 year ago2 mins

Mentioned in story

You’ve probably seen this before: if you missed the 10 best days in the S&P 500 over the past 30 years, your returns (green line, above) would be about half of what they’d be if you hadn’t (dark blue line). It’s a stat that argues in favor of buying stocks and holding them, and not trying to time markets, because the cost of missing out on those big rally days is too great.

But it’s highly misleading: for starters, how likely is it that you would have missed those exact 10 days? The fact is, these extreme daily gains often follow extreme losses, and in many cases, they precede further losses. The investor who was on the sidelines during those key daily gains was also likely to have avoided the losses around those days. In other words, looking at the gain in isolation makes little sense.

The same can be said about the largest daily losses: as the red line shows, if you’d missed the 10 worst days, you’d have nearly four times the returns of the S&P 500. And what if you – very hypothetically – missed the 10 worst and 10 best days in isolation? Well, you’d have actually beaten the S&P 500. The reason is twofold: extreme losses tend to be larger than extreme gains, and losses compound more than gains do – it takes a 100% gain to recover from a 50% loss, after all. So avoiding the 10 worst days would have more than made up for the cost of missing the 10 best days. Hypothetically.

So if the goal of this chart was to make you consider – or not – the value of market timing, it failed. To do that, you’d need to look at proper market timing strategies – like the one we explored here. Instead, the biggest takeaway of this chart is this: when you see a sensational chart, always look at it with a critical eye and consider whether the underlying assumptions make sense. Quite often, they don’t.

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