StanStu #2: Missing the Best Days

Some weeks ago, I came across the what feels like 27th iteration from one of my favorite Standard Stupidities: a hypothetical calculation of what happens to your returns when you miss the best days of the stock market. The issue was even discussed at a conference held by one of the world‘s leading banks, which I attended at the end of 2024. So I decided to write about it once and for all.

Unlike many other Standard Stupidities, this one is technically not false and often actually used with good intentions. But good intentions don’t save something from being misleading, and I believe serious investors should aim for an intellectually honest and evidence-based view.

The S&P 500 (obviously) returned less without the best days

We will start by taking a closer look at the enemy we are facing. There are countless charts out there that show what happens to long-term equity returns when you miss the best 1/5/10/… days. Ironically, I now joined the people whose charts I criticize by creating the example below. Like most examples from the industry, I do it for the S&P 500. But this generally works with every time series as it is really just a mathematical exercise.

Own illustration and analysis. Returns refer to the S&P 500 Total Return Index (including reinvested dividends) from 1988-01-2024 to 2024-12-31. The sample period corresponds to the longest possible history available from the data provider. Data from financialmodelingprep.com.

What do we see? The chart illustrates what happens to the total returns (including reinvested dividends) of the S&P 500 Index when we exclude the best 1/5/10/15/20 trading days in the almost 37-year sample period from January 4, 1988 to December 31, 2024.1The strange sample period is the maximum available history at the data provider I use for this analysis. Fortunately, it doesn‘t change the overall message in this case.

Unsurprisingly, excluding more Best Days steadily decreases long-term returns. Thanks to compound interest, even apparently small differences like the 30 basis points between Fully Invested (11.2%) and Missing the Best Day (10.9%) translate into large wealth differences over such a long period. This is (obviously) most extreme when excluding the best 20 days. In this case, the annualized return drops to 7.3% and $1 “only” grows to $14 versus $50 for the fully invested benchmark.

These statistics are undoubtedly impressive at first glance. Investment managers (and some sales people) therefore often use them to argue against market timing and to encourage investors to stick with a long-term strategy. Needless to say, I generally agree with those two virtues and may even believe that some people in the industry actually do have good intentions.

To provide some more context and intuition, the following table lists the 20 best and worst days of the S&P 500 in this sample period. As you can see, there are some quite extreme days on both ends. So it is not surprising that if you miss such a day, you may lose (or gain) a lot of long-term performance. In fact, if you assume long-term expected returns on stocks in the order of 8%, some of the best or worst days can theoretically define an entire year.

Own illustration and analysis. Returns refer to the S&P 500 Total Return Index (including reinvested dividends) from 1988-01-2024 to 2024-12-31. The sample period corresponds to the longest possible history available from the data provider. Data from financialmodelingprep.com.

These analyses may be impressive, but in some sense, they are just obvious. It is no surprise that the sum gets smaller when you exclude the largest elements from its set of numbers. Turbo-charged by the mechanics of compound interest, this logically creates those extreme differences over long periods. Of course, there is nothing wrong with presenting obvious insights. In fact, simple (but correct!) analyses are actually the best ones.

The problem, in my view, is that such charts can be easily misleading. There are endless ways to calculate hypothetical returns after the fact and believe me, the result will magically support whatever argument you like. In the next paragraph, I will illustrate this by simply doing the exact opposite of above. Once you exclude the worst instead of the best days, the case for market timing suddenly looks very attractive.

The S&P 500 (obviously) returned more without the worst days

Just taking the opposite approach from above, the chart below shows what happens to the total returns of the S&P 500 when you miss the 1/5/10/15/20 worst days between 1988 and 2024. Returns now obviously increase when we leave out more Worst Days.

Own illustration and analysis. Returns refer to the S&P 500 Total Return Index (including reinvested dividends) from 1988-01-2024 to 2024-12-31. The sample period corresponds to the longest possible history available from the data provider. Data from financialmodelingprep.com.

To this date, I have rarely seen this variant of the chart in industry research.2Which surprises me as this would the be perfect (but misleading!) pitch for someone who claims to do successful market timing. I hope that I do not contribute to such a development… Both charts are purely hypothetical, yet technically correct in the sense that they reflect data and empirical facts. The apparent conclusions, however, are very different. The first one highlights the risks of missing the best days and argues in favor of staying fully invested. This second one highlights the potential profits from leaving out the worst days and may be an argument for market timing.

Own illustration and analysis. Returns refer to the S&P 500 Total Return Index (including reinvested dividends) from 1988-01-2024 to 2024-12-31. The sample period corresponds to the longest possible history available from the data provider. Data from financialmodelingprep.com.

The last chart brings it all together. It shows the final wealth of all hypothetical scenarios compared to the fully invested benchmark. Once again, compound interest does its job. If you left out the 20 worst days, you ended up with 344% more wealth than the fully invested benchmark. On the contrary, you would have 73% less after missing the 20 best days. So if anything, what should we take away from such hypothetical exercises and those numbers?

None of it is really useful (and possible) in practice

Thus, every active bet placed in the pursuit of above average returns carries with it the risk of below average returns.

— Howard Marks, 2022, URL

The reality is that market timing is a double-edged sword. There is a lot to win when it is successful and a lot to lose when it is not. This is not surprising as market timing is nothing but active investing (see AgPa #3), which always comes with both the potential for outperformance and the risk of underperformance. With this in mind, let me give you a few concluding thoughts.

First, serious investors should (in my view) not allow themselves to be influenced by cherry-picked hypothetical returns. I agree that showing people the substantial risks of market timing may serve the noble intention of encouraging long-term thinking and discipline. But it is still not intellectually honest and also not very robust. As we have seen, we can just create the opposite hypothetical calculation to show the potential profits from avoiding the worst days. Both examples are mathematically correct, but practically misleading.

Second, all of the illustrations and calculations are purely hypothetical anyway. The probability that a real-world investor can and will leave out those particular worst and best days in the future is close to zero. There is evidence on successful market timing on longer horizons with strategies like momentum or trend following (see AgPa #37). But anyone who claims that it is possible to pick the right set of days in a multi-decade period is (in my view) very dubious.

Third, the actual core of the issue is nothing but market efficiency. There is a lot of empirical and theoretical evidence which shows that successful active investing is very difficult (see AgPa #10, #17, #35). In particular for the stock market and especially over long periods. I mean, if there is any easy way to skip the worst days of the stock market (or even short it on these days), we would all do it, right?

If you made it till here, you may (rightly) conclude that this post is somewhat idealistic and nerdy. Why bother with Missing-the-Best-Days charts when they actually encourage some investors to do the “right” thing, which in most cases is just staying fully invested? Well, if the fear of missing returns on the best days helps to improve outcomes, this is of course a valid tool. I cannot argue with this.3I also use such tools. For example, my wife and I don’t want to eat candy in our daily lives. The only way to achieve this is to not buy them in the first place. Not entirely rational, but it works…

However, I still believe that serious investors should not make decisions based on constructed hypothetical return calculations. Yes, in this Missing-the-Best-Days example, it may nudge you in the right direction. But in many (if not most) other cases, it will probably not.



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Endnotes

Endnotes
1 The strange sample period is the maximum available history at the data provider I use for this analysis. Fortunately, it doesn‘t change the overall message in this case.
2 Which surprises me as this would the be perfect (but misleading!) pitch for someone who claims to do successful market timing. I hope that I do not contribute to such a development…
3 I also use such tools. For example, my wife and I don’t want to eat candy in our daily lives. The only way to achieve this is to not buy them in the first place. Not entirely rational, but it works…