There is a simple lesson for traditional losers: Since you cannot time the market, the only way to make money is by staying in it for as long as it takes.

The Smart Investor did a study covering the period from September 1979 to August 2003, comparing your returns if you had stayed invested in the market at all times - bull, bear and neutral periods - and if you had woven in and out of markets in good periods.

The study tries to bring out the risks and rewards associated with market timing - or the lack of it. It examines what would have happened to your total returns (as indicated by the Sensex) if the market's best and worst months and days are eliminated from the calculations. This is what we found:

• If you are an excellent market timer - that is, you stayed for the bull periods and opted out of the worst times - you could have made returns of more than 50 per cent a year.
• If you are a lousy timer, you could have lost your shirt - losing around 17 per cent annually. Your money would have been safer under your pillow.
• If you didn't time the market at all, and stayed invested all through the years, you would have made 16 per cent annually.

The findings (September 1979 - August 2003)

The study shows that by being 'out of the market' for just a few months during this period, the risks and rewards change dramatically when the months missed were those with the highest or lowest returns.

During this 24-year period, the Sensex gave a compounded annual return of 15.90 per cent as it surged from 116 to 4004. So Rs 100 invested in the Sensex in September 1979 would have cumulated to Rs 3,449 at the end August 2003, after 288 months, or 24 years.

• When we eliminate the best months, the returns fall dramatically. For instance, if you missed the best 10 months over 24 years, your return would have fallen to 5.54 per cent. Your Rs 100 would have grown to Rs 365 at the end of August 2003. Similarly, eliminate more best months, say 20, and your annualised return would even have turned negative. And if you eliminate the 72 best months (25 per cent of 288 months), you would have simply wiped out your entire portfolio and left with just Rs 1.17!
• If we eliminate the worst months, say the top 10 of them, then your annual return would have been 23.79 per cent over the same 24-year period. Similarly, if you avoided the worst 72 months, you would have ended up with - hold your breath - Rs 25,44,879! A phenomenal 52 per cent annualised return.
• If we eliminate both the best and the worst, your annualised return for the three scenarios (that is eliminate the 10 best and worst, the 20 best and worst, etc.) would have been 12.73 per cent, 11.65 per cent and 9.39 per cent respectively. So, Rs 100 invested in September 1979 would have cumulated to Rs 1,773, Rs 1,409 and Rs 862 respectively in the three scenarios.

The last decade (September 1993 - August 2003)

During this period, when the market saw the arrival of big institutional players and better stock research, the effect of extremes was more dramatic. During the period, the Sensex moved up from 2,634 to 4004, and gave a compounded annual return of 4.28 per cent.

This means you would have been almost as well off letting your money rot in a savings bank account, and clearly better off with money in a fixed deposit.

• Instead, if you had not been in the market during its best 10 months, you would have ended up with negative returns straight away (-9.08 per cent). An investment of Rs 100 would have shrunk to Rs 38.59 at the end of 10 years. And it gets worse as we eliminate more of the best months.
• If you had managed to avoid the worst 10 months, Rs 100 would have grown to Rs 549.98, an annual growth rate of 18.59 per cent. If you missed the 20 worst months, you would have landed up with a 28.73 per cent return. Similarly, if you missed the 30 worst months (25 per cent of the total period) you would have made annualised returns of 38.93 per cent and the value of Rs 100 would have appreciated to Rs 2,678.85.
• Again, if we eliminate both the best and the worst, your annualised return for the three scenarios would have been 3.39 per cent, 4.16 per cent and 5.14 per cent respectively. So, Rs 100 invested in September 1993 would have cumulated to Rs 140, Rs 150 and Rs 165, respectively, in the three scenarios. In other words, during this period, unless you avoided the worst months and stayed invested in the best months, your chances of making better returns by timing the market would have been bleak.

Perfect timer vs inept timer

A perfect timer - who avoided all the negative months while being in the market in all the positive months - would have grown his investment of Rs 100 into Rs 96,40,556 during the period 1979-2003 - an annualised gain of 61.31 per cent. On the contrary, an inept timer would have reduced his portfolio to Rs 0.72, by compounding annual losses at the rate of 24.48 per cent.

Similarly, a perfect timer would have grown his investment of Rs 100 into Rs 6,562 during the period 1993-2003 - a annualised gain of 51.95 per cent. An inept timer would have reduced his portfolio to Rs 3.82, an annualised loss of 27.86 per cent during the same period.

Conclusion

It is well known that the market does not rise or fall steadily. Instead, there are days or months when the market soars or plunges. What's surprising is that a tiny portion of those brief swings accounts for practically all of the market's gains or losses over decades.

So market timing is perhaps even more difficult and risky than investors have been led to believe. A better way is to stay invested at all times so that you don't miss the big moves when they happen.

Market timing is only for those who are confident of predicting the future. Others would be better off staying invested at all times and routing investments in stocks through systematic purchases, or 'rupee-cost averaging'.

If you had invested Rs 100 in Sep 1979, your investment would be worth (in Aug 2003) . . .

• Rs 3,449 (15.90% per annum) If you had stayed invested throughout
• Rs 365  (5.54% per annum) If you missed the best 10 months
• Rs 86 (-0.65% per annum) If you missed the best 20 months
• Re 1 (-16.93% per annum) If you missed the best 72 months