The Best of the Worst… Or Vice Versa, for that Matter

September 30th, 2011
by Portico Wealth Advisors

From time to time, industry notables publish pieces on the effect of missing a certain number of the best trading days over a particular time period. Most commonly, the 10 best trading days are subtracted from performance, but over the years there have been many derivations in which the 20, 30, 50, and even 100 best trading days were omitted.

The graph below (courtesy of www.mymoneyblog.com) is no different.  It tracks the since inception performance of the S&P 500-mimicking SPDR ETF (Symbol: SPY) from State Street Global Advisors.

 

Click Graph to Enlarge

 

As the red line depicts, missing the 10 best trading days over this roughly 17-year period was costly. Simply buying and holding $100,000 of SPY from January ’93 to June ‘10 (the blue line above) yielded an investor $324,330, or ~7.2%/yr. Whereas, had you missed the 10 best trading days, a mere .2% of the total trading days during the period, your account only grew by ~2.7%/yr to $156,234. Given the dramatic difference in return relative to the small number of trading days in question, this type of analysis is used often to justify a buy-and-hold strategy.

Of course, after seeing a multitude of these studies, others began to ask an equally valid question, i.e. what if an investor were able to avoid the 10 worst trading days over a given period? As expected, the results were dramatically better than buy-and-hold. For the same 17 year period, an investor that was skillful enough to avoid the 10 worst trading days was able turn $100,000 into $692,693, representing a return of better than 12%/yr (the yellow line above).

So what then is the green line? The green line shows the result of missing both the 10 best and 10 worst trading days for SPY since January ’93. Notably, the green line performed only marginally better than the simple buy-and-hold strategy (the blue line).

What’s more, the returns associated with the blue line were remarkably easy to achieve, whereas the returns of the red and yellow lines were not. Obviously one produced a much more desirable result than the other, but both relied equally on an investor’s ability to identify just 10 out of 4,284 days correctly.

Ironically, the green line was the most difficult performance of all to reproduce. In order to achieve green line performance, which was almost identical to blue line performance, an investor would have needed to make 20 über-prescient decisions over the same period.

Seems like a lot of work, given the rewards associated with the much more elegant (and effortless) buy-and-hold.