Financial Markets and Roller Coasters

Cycle of Market Emotions
by Dennis Fulkerson
RSM McGladrey

If you’re a reader of the financial press, you have no doubt heard the financial markets compared to a roller coaster ride. But is this a fair comparison? At first glance it sure seems like it. For one, if you do a Google search for roller coaster names, several come up that can certainly relate to various market cycles: Raging Bull, Big Dipper and Teddy Bear. To be sure, each of these names evokes some sort of emotion.

As investors, you’ll undoubtedly see various market cycles during your investing lifetime, and you’ll need to adjust your expectations accordingly. However, many of the similarities between financial markets and roller coasters end here. On almost every roller coaster ride, each rider can see and anticipate the peaks and valleys, twists and turns, before they happen. In the case of the peaks and valleys, roller coaster riders know exactly where they start and end. As we know, this clearly isn’t the case in financial markets. For example, the financial press is inundated with economists’ predictions, which ultimately, months later, are followed up with updated predictions and the reasons why their initial predictions were obviously flawed.

But it’s hard to successfully time the markets and the dramatically worse results that are achieved when the market timing strategy fails. For instance, the annualized return of the S&P 500 from January 1, 1970 through December 31, 2007 was 11.07 percent. If you were an investor who started the period with $1,000, you would have ended up with $54,118. Though, if you were to try to time the market and you missed the 25 best days (which is only 0.18 percent of the 13,879 days in the period), you would have returned only 7.74 percent and turned the $1,000 into only $16,993, or $37,125 less. What are the chances you would have known when those 25 best days were to come? Now, let’s say you missed only the five best days (only 0.04 percent of the 13,879 days); your return would have been only 10.21 percent or 0.86 percent less per year. Basically, it’s fair to say that market timing won’t work.

Remember, this general rule applies to all theme park patrons: The greater the twists and turns, peaks and valleys, the greater the thrill of the ride. Yet, keep in mind that all fairs have more than roller coasters to enjoy; there’s always the carousel or the Ferris wheel—rides that can still provide enjoyment. The same is true in investing. While greater risk can bring greater reward, it’s essential to have the appropriate allocation that matches your goals and objectives and also matches your need and ability to take risk. iBi