I have come across so many people that are currently sitting on the sidelines and waiting for the stock market to drop before they jump in. So I figured it would be as good a time as any to talk about this popular strategy.
Market timing. Everyone thinks they can do it, I sure did. I think maybe we are all born with this bravado.
But it’s a horrible idea.
Now I know firsthand that volatility can be very unsettling, and can make market timing seem like a good way to counter, but we all need to resist this temptation.
Because it’s so important to not only be in the market, but to stay in the market through all the ups and downs.
Market Volatility Is Completely Normal
Just like winter, big market drops tend to happen each year. Historical data shows that a 5% pullback in the stock market occurs about once per quarter on average, while a 10% decline or greater happens pretty much every year. Even a 20% bear market decline happens roughly every five years.
But it is especially important to be invested in the midst of this volatility because the best and the worst days in the market tend to be clustered together.
From 1997-2016, six the market’s ten best trading days came within two weeks of it’s worst trading days. In fact, the period’s best trading day occurred only two days after it’s worst day in August 2015.
So if you were lucky enough to miss the worst days, you were also very likely to have missed the best days as well.
And if you missed even a few of the best trading days, you’d be in real trouble. Let me explain.
The Cost of Market Timing
JP Morgan completed a 20 year study* from that exact time period to see what effect, if any, missing out on the best trading days would have on a portfolio.
During those 20 years, the S&P 500 averaged a 7.7% annual return, meaning you would double your money every nine years if you had stayed invested the entire time. Not bad at all considering we went through the 2000 tech bubble bursting, 9/11, two wars, and a devastating global financial crisis and economic recession to boot.
The study found that if investors were sitting on the sidelines during the market’s ten best trading days over that 20 year period, their annual return would have dropped from 7.7% to 4.0%, or nearly half.
If an investor missed out on the top 20 trading days? Their annual return would have dropped to 1.6%. With a return like that, you would double your money every 45 years. Yuck.
And if an investor missed the top 30 trading days over those 20 years, which equates to just 1.5 days a year, they would have lost money each year.
Now investing is by no means an easy game to play, but there is a clear way to win both economically and just as importantly, psychologically.
Invest in the market on a consistent, automatic basis via low-cost index funds.
Then forget about it, let your money work hard for you in the background and focus on the things in your life that you can actually influence.
If I didn’t come across so much research that overwhelmingly validates this strategy, I wouldn’t be saying it over and over again. If there was a better way, I’d tell you about it.
But the beauty of this investment strategy is it’s also the simplest. As counterintuitive as it may seem, when it comes to investing, the less you do, the better off you will be.
When winter comes and the stock market drops, your automatic contributions will be buying shares at a discount. And your portfolio will be receiving dividends from the hundreds or thousands of companies you are invested in through these index funds every quarter, rain or shine.
So let’s just relinquish control by embracing the fact that we don’t know (or care) how the market will perform on a short-term basis, and then reap the benefits by just riding the waves and investing over the long term. Sounds easier, doesn’t it?
Jack Bogle, Founder of Vanguard and inventor of the index fund (my personal hero) has a quote that sums all of this up quite beautifully.
“My rule – and it’s good only about 99% of the time, so I have to be careful here – when these crises come along, the best rule you can possibly follow is not “Don’t just stand there, do something,” but “Don’t do something, just stand there!”
*JP Morgan released an updated study with similar findings