Why you shouldn't try to time your stock market investments
If you plot stock prices over many years, you will see that for most indices even the real crisis periods of collapsing stock prices look more like minor corrections to a longer, quite stable upward trend. And when you think of it, that is actually not so surprising. Companies are there to make money, and as a shareholder you own a part of that profit. In the long run, stock prices follow the value created by the underlying companies.
Take the year 2000, at the peak of the tech bubble. That is an extreme example, because when I look back over the last 30 years, that was the only time when I found it very evident that stock prices were in a bubble – in the moment, and without the benefit of hindsight. So with a bit of common sense you would not have started to invest in stocks in any big way just that year. But assume you did buy the Dow Jones index of big US companies right at that peak in January 2000. You would have paid 11,700. Today, the Dow Jones is around 24,600. So over those 18 years, you doubled your investment plus you cashed in on the dividends on the way. Not a very “sexy” performance? Well, at least not something to be afraid of.
That’s all nice and good, you will say, but the years following 2000 were no fun, and nor were the years 2007 to 2009. Tough times indeed. So… can we avoid the value loss of those bad years, and only be invested in the other years? Should we even get in and out of the market more regularly in order to sell high and buy low? There are many professional traders who try to do just that. And quite a few make a decent living out of that, so it doesn’t seem to be impossible.
So… should everybody get into this game of buying and selling?
Here is an answer from Investopedia which I think is spot on:
“For investors, the real costs of lost time and opportunity are almost always greater than the potential benefit of shifting in and out of the market.
Opportunity Costs: Research shows that, if an investor remained fully invested in the Standard & Poor’s 500 Index from 1995 through 2014, he would have earned a 9.85% annualized return. However, if he missed only 10 of the best days in the market, his return would have been 6.1%. Some of the biggest upswings in the market occur during a volatile period when many investors flee the market.
Transaction Costs: Countless studies have shown that mutual fund investors who move in and out of funds and fund groups trying to time the market or chase surging funds underperform the indices by as much as 3% due to transaction costs, especially when investing in funds with expense ratios greater than 1%.
Taxation Costs: Buying low and selling high, if done successfully, generates tax consequences. Add to this the hidden tax consequence of investing in high turnover funds that generate substantial tax consequences affecting investor returns.
While market timing is not impossible to do, few investors have been able to predict market shifts with such consistency that they gain any significant advantage over the buy-and-hold crowd. In the estimation of Morningstar, actively managed portfolios that moved in and out of the market between 2004 and 2014 returned 1.5% less than passively managed portfolios. According to Morningstar, to gain any edge, active investors have to be correct 70% of the time, which is virtually impossible over that time span.” End of quote.
But here is one way to beat the market. We call it drip feed. Invest the same amount of money every month, keep doing that over the next, say, 15 years, and never cash in during that period. Funds reproducing stock market index returns are very good vehicles for that. Now this may be counterintuitive – how can you beat the market if all you do is investing in indices representing the market? Correct: Every month you make an investment that will perform in line with the market. But the trick is that in your portfolio the relative weight of the stocks you bought in "weak" months will be higher: You buy more stocks when prices are low. That effect is called cost average effect.
Anyway, my overall conclusion is this. If you want to benefit from stock market returns (and if you have any money invested, I believe stocks should be part of that), you just have to be part of the game.
Woody Allen once said: “80% of success is showing up”. I think that equally applies to stock markets.