Morningstar Investor users sign in here.

Video

The critical reason to stay invested

Why it's important to stay invested to capture critical months for your portfolio, with Morningstar's director of investment research, Ian Tam


Editor's note: Read the latest on how the coronavirus is rattling the markets and what you can do to navigate it.

Ian Tam: Over the last week or so, equity markets continue to be very turbulent and very volatile. In fact, sliding further in terms of losses in the last few days. Recently, I put out a video on three things to remember during turbulent times. Number one, keeping your emotions in check; number two, understanding your risk tolerance and sticking very close to the amount of risk you're able to take on; and number three, not trying to time the market.

So, today, what we're going to focus in on is a concept called critical months. And many investors know that equity markets are certainly very volatile. But you may not know that the performance of an index is often dependent on a very short period of performance history.

So, let's have a look at the chart on the screen here, which is an illustration of an equity index. And what I'm going to do is use an example of the 2000 tech bubble focusing on the year 2000 or so. And what this chart basically shows is that had you missed the one best month of performance within that given year, your performance in that year would have been about negative 18 per cent. But had you been invested during the entire year despite it being a negative year in equities, your return would have been closer to negative 11 per cent or negative 12 per cent. So, still not a great scenario, but certainly would have paid you had you been invested during the entire year.

To go a bit further on this point, let's have a look at another chart, which is an illustration of a study that my colleagues Dr. Paul Kaplan and Dr. Maciej Kowara did in 2018. And they basically studied about 3,700 funds globally, equity funds specifically, over a 15-year period. And through the study, they defined what's called the critical months. So, a critical month basically is one that had you removed the performance of that month, the fund would have failed to beat its own equity benchmark.

So, amongst the 3,700 funds that they studied around the world over that 15-year period, they found that on average, there were just 7.4 or 7.5 critical months. So, the dependence on outperformance during those months is very small compared to the amount of history that we're actually looking over. And that's not just a global phenomenon, it also applies specifically to Canada. So, in Canada, my colleagues found about 304 equity funds that outperformed their benchmark over that same period. And they found that during that 15-year period, there were only 7.8 critical months.

So, again, this is just a reminder to all the investors out there that it's very important to make sure that you stay invested, despite the fact that there's a lot of volatility because the performance of your fund over the long term depends on a very small period of time.

For Morningstar, I'm Ian Tam.



© 2023 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This report has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or New Zealand wholesale clients of Morningstar Research Ltd, subsidiaries of Morningstar, Inc. Any general advice has been provided without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide at www.morningstar.com.au/s/fsg.pdf. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782.

More from Morningstar

Bank results: the winners and losers
Video

Bank results: the winners and losers

Morningstar analyst Nathan Zaia explains how the banks did and what the future holds.
How to deal with financial stress
Video

How to deal with financial stress

More high-income earners are now also experiencing financial stress. We go through practical ways to reduce it
UniSuper CIO John Pearce on why the 60/40 portfolio is far from dead
Video

UniSuper CIO John Pearce on why the 60/40 portfolio is far from dead

The $130 Billion SuperFund Manager also talks about how he sees risk, his recent investments, and why history isn’t a good guide to the future.
Incitec Pivot: explosive upside ahead?
Video

Incitec Pivot: explosive upside ahead?

Morningstar analyst Mark Taylor believes imminent growth in explosives earnings could lift sentiment.
Why Morningstar see opportunities in coal stocks
Video

Why Morningstar see opportunities in coal stocks

Analyst Jon Mills explains why he’s recently increased fair value estimates for Australian coal companies.
Is the sharp fall in ResMed's share price justified?
Video

Is the sharp fall in ResMed's share price justified?

The potential for weight loss drugs to impact the sleep apnea giant has weighed on the share price, though Morningstar analyst Shane Ponraj thinks...