Successfully Timing The Stock Market: A Tough Ask!
There is an old investing adage: Time in the market beats timing the market. Even in a normal investment climate, adhering to this sage advice is tough for many individuals. It is downright impossible for most investors when the stock market is 1) setting all-time highs on what seems a daily basis, and 2) riding a 70%+ rise from the lows set nearly one year ago. The itch to time the market (i.e., try to sell at the perceived top) strengthens with each new high. History and experience tell us, this is an itch you do not want to scratch!
The mere idea of market timing is flawed from the get-go. Some of the most successful investors are those who buy and hold stocks for the long-term. For these folks, the goal is to find great companies selling at the right price and then invest in them. Essentially, one decision needs to be made to achieve success. This is not the case for a market timer. Let’s count the number of instances a market timer needs to be correct in order to achieve some modicum of success.
The trader must:
1) Be able to make an investment that increases in value (like the long-term investor), then
2) Know when to sell said investment prior to its pending decline, then
3) Know when to re-enter the stock market at its low (or near low), and then, last but not least
4) Decide what stock(s) to buy upon re-entering the market. It stands to reason that if you are trading out of certain stocks, when you re-enter the market there is a good chance your trading inclination will steer you towards other better-looking stocks.
My eleven-year-old knows it’s harder to be right four times versus just once. As a market timer, you best be on your game. Any slight mishap could cause significant damage to your portfolio returns. Take a look at the above chart. For the period from 1990 – 2017, if a market timer was not invested for the single best day each year, he/she would underperform the stock market (as measured by the S&P 500 Index) by nearly 4% a year! Miss even more days and the pain accelerates. Unfortunately, this is just the beginning…
The reality of market timing is you are changing sides. You no longer have the singular belief that stocks rise over the long-term. You may still believe this, but you have introduced a second thought that you can sell out of the market before it corrects to the downside. If this is your behavior, the odds are you will miss more than just the one best day. You called the market high for a reason, so there is a strong probability you will cling to this thesis until you are proven correct or maybe even worse… buy back after much of the investment return has been made.
Unfortunately for the market timer, bull markets last much longer than bear markets. Look no further than the chart to the right. Yes, bear markets are tough to stomach, but you have to bear with them (pun intended) in order to ensure you participate in the entire growth of the stock market.
Lastly, looking at this chart you have to wonder or be fearful of entering the stock market near or at a market top. What happens, if you make your first investment in month 134 of a 135-month bull market? Shouldn’t you wait to till you see a correction before investing? Market timing has to make sense here, right!?!
Well, in the real world, where you most likely will not time the market to get out at the high, you are most likely not going to invest at the exact worst time (i.e., a top before a correction). But, for the sake of argument, let’s pretend this happens.
To the right is a graphic that depicts an individual that in January 1970 began saving $1,000 a month into their bank account. They did not invest it in the stock market until a market peak. The first peak was 1/11/1973. On this date, this person had savings of $48,000, invested it in the S&P 500 Index and subsequently watched 48% of its value evaporate. The horror!
Fast forward to this past year end and you see what that initial investment is worth today… 3,000% more. This person continued to save $1,000 a month between corrections and did not make an investment until the market peak. In each case, the initial investment has provided a positive return thru 12/31/2020. It is clear the longer you stay invested the greater your return. In fact, on average it takes a little over 4 years to recoup your original investment from a correction of 20%+. This might be why, investment professionals (such as us) pontificate to only invest in the stock market if you have 5+ years to ride out the volatility.
Regardless of the 900 or so words I’ve written here, clearly illustrating that trying to time the market is hard and quite frankly has no purpose; people will continue to try. The stock market is certain to correct in the future, as history and experience tell us so. History and experience tell us something else as well… the more time in the market the better off you will be.