Selling out and avoiding the worst days: is this the best way to beat the market?

Investors are often advised to stay calm and fully invested, but Jonathan Jones looks at a new philosophy for superior returns

Investors are more than happy to put their money to work while markets are rising, yet often match this with a knee-jerk reaction to sell when things take a turn for the worse.

To stop this irrational behaviour many are advised to stay in the market through the good and the bad.

But what if there was another way? With the General Election likely to lead to stock market swings, Telegraph Money has looked at whether investors would be better off swapping stocks for cash.

An important consideration before deciding is that a high proportion of long-term returns come from a small number of strong days. Missing these days by holding cash can therefore be significantly detrimental to returns.

An investor who missed the 10 best days of the past 20 years would have made a return 170 percentage points lower than one who remained fully invested in the FTSE All-Share index throughout.

This also works in a global context. Over the past 30 years, if an investor had missed out on the best 10 days, their return would have been 189 percentage points lower. Missing out on the best 40 days would have meant losing money overall.

These figures strongly support staying invested. However, Ben Leyland of JO Hambro Capital Management, a fund group, takes an opposite view.

Analysis shows that missing out on the worst days has had a much bigger impact on returns than being invested on the best days. Investors would have more than doubled their return if they had missed the worst 10 days, versus being invested at all times. Mr Leyland said: “When markets rise they tend to take the stairs, but when they fall they come down by the lift.”

So what should investors do as the election approaches? Some observers expect markets to react strongly to the outcome of the vote on Dec 12, as people are understandably nervous at the moment.

Mr Leyland’s analysis suggests that, as we approach polling day, it may be best to sell some holdings and keep the money in cash. However, neither missing the worst days nor picking the best is realistically possible. Timing the market is notoriously difficult, and the best and worst days tend to cluster together.

The worst day in the past 30 years in global stock markets, Oct 15 2008, came just two days after the best day. Six of the 10 best days and eight of the 10 worst were in 2008.

Mr Leyland agreed that trying to time the market was a “mug’s game” but said the compulsion always to stay fully invested regardless of circumstances could also be detrimental to long-term returns. “It is just as heroic to insist on remaining fully invested as it is to stay completely out of the market waiting to time your entry right at the bottom,” he said.

Instead, he advised investors to buy stocks that will hold their value better in a recession while selling more speculative shares and holding some cash on the sidelines.