In financial markets, this has not been a year for the faint of pocket. Both the S&P 500 and the MSCI World Index are down more than 20% year to date. In June, both indices plummeted by 10% in just five trading days.
Suspecting a bit of encouragement here? Right on. There are profits to be had from such market movements. At least if history repeats itself, which of course it never does.
Just check these figures: If you had bought into the MSCI World Index every time it fell by that much in five days and stayed put for the next 100 trading days, you would have captured an average annualised gain of 23%.
The worst 100 trading days this year delivered a loss of 17.7%. If you had followed the same strategy here, investing and staying put for another 100 days, you would have reaped an average annualised gain of 27%.
I have performed similar calculations for both the OSE benchmark index and the S&P 500. They all yield similar results: On average, such a strategy would have produced wonderful gains. Do note that average clause, though.
Let’s have another look at the figures here. The MSCI World Index goes back to the beginning of 1970, with a compound return of 9.3% in US dollars. If you started 1970 with a capital of $100, you would now have close to $11,000. If you’d been lucky enough to reap 27% a year, you would have $32 million.
“In the meantime, waiting for the big catch, you’d have an opportunity cost to boot. ”
Except you wouldn’t. There’s a snag, and it’s a big one: You would only be invested for a small part of this period. In the meantime, waiting for the big catch, you’d have an opportunity cost to boot. Your money would idle away months and years in a bank account.
Imagine your friendly banker granted a deposit rate of 4%. In that case, with stretches of 27% annualised gains thrown in, your initial $100 investment in the MSCI World Index would have turned into less than $1,400. That’s a lot less than $11,000 – despite those wonderful profits you would have made from time to time. And that’s assuming your local tax collector turns a blind eye to the interest income and the intermittent gains.
Surprisingly unprofitable? There’s a strategy that would have been even more unprofitable. If, after every 100 trading days that scared the grit out of you, you decided to be short for the next 100 days, your compound return would be a measly 2.5% – despite interest accruing continuously at 4% on your investment (and on the amount sold short).
That’s a risk there is no point in taking.