Business Insider – May 12, 2021
When the Dow Jones Industrial Average dropped below 20,000 at the height of pandemic panic in March of 2020, many investors and others assumed the worst. People I know tinkered with their retirement assets, moving most of them to cash. Others paused their normal investing contributions in favor of sitting tight. Maybe more pain was yet to come, and waiting it out could protect against even more losses later in the year.
- Studies show that timing the market rarely works in the long-term.
- Financial advisors say you don’t need a lot of big wins along the way to build wealth over time.
- Instead of timing the market, consider investing the same amount of money each month.
But, a lot of people did nothing, so they never realized any losses at all. In the meantime, the stock market has recovered and then some since those dark days in March and April of last year. This just goes to show that, a good portion of the time, the best investment strategy is doing nothing at all.
This also proves that timing the market doesn’t really work, which is something index fund investors like myself have known all along. Why is attempting to time the market a poor investing strategy? Financial advisors explain.
Markets go up over time
Unless you’re planning to retire in the near future, you don’t have to care too much about the movements of your investments on any given day. Colorado financial advisor Matthew Jackson of Solid Wealth Advisors says this is due to the fact that markets have a history of going nowhere but up over time.
“Despite two World Wars, a Great Depression, many regional wars, a presidential assassination, Black Monday of 1987, the 2000-2001 tech bubble, the 2008 market sell-off, and the COVID pandemic, the stock market has continued to rise in value,” says Jackson. “If an investor had waited for better times to invest, that person may still be waiting.”
The best investing plans are boring
Chicago financial advisor Christopher Clepp of Strategic Financial Group says the biggest problem you can get into with speculative investments is that they can become the focus of what you are investing in.
“If the basis for your retirement plan is those YOLO meme stocks, then you are gambling too much with your future,” he says.
Instead of worrying about the next big thing, Clepp says you should take care of the investing basics. For the most part, that means making sure you have a comprehensive financial plan in place with the right asset allocation for your risk tolerance and timeline.
“It may not sound fun or glamorous, but sound financial planning rarely is,” he says.
Nobody has a crystal ball
Wouldn’t it be nice if you could get a glimpse at the value of your favorite investments five or 10 years from now?
If you could, you would know for sure whether you should stay on the path you’re currently on, invest as much as you can, or sell and cut your losses now.
Unfortunately, that’s not reality.
Orange County, California, financial advisor Christopher Struckhoff of Lionheart Capital Management says people in general are not great at timing the market because it ultimately involves predicting the future.
“And no one can perfectly predict the future,” he says.
To win at market timing, you have to buy and sell your investments at the perfect moment. Without a crystal ball, it’s nearly impossible to buy or sell at the exact right time, let alone both.
Transaction costs add up
Struckhoff also points out that active trading increases transaction costs, even on free trade platforms that use payment for order flow where you might not be getting the best price execution. Not only that, but how much of your returns are you keeping after you pay taxes (assuming you’re investing in a taxable brokerage account)?
Struckhoff points out that investments held for less than a year require you to pay short-term capital gains taxes, which are much higher than long-term capital gains. If you’re constantly buying and selling, you could be running up transaction costs and your tax bill all along.
‘All-time highs’ don’t mean much
Financial advisor Tony Liddle of Prosper Wealth Management says too many people wait to invest because markets are nearing all-time highs, or they believe they’re overvalued. The thing is, it’s not that uncommon for markets to hit or linger near all-time highs, yet each new threshold reached is yet another all-time high you’ll see on the news.
To put things in perspective, the Dow hit 30,000 for the first time in November of 2020 after the pandemic, yet it has gone up more than 10% since. If you waited to invest in November due to the new record high, you would probably still be waiting on the sidelines, and you would have missed out on generous gains to boot.
In terms of markets being overvalued, Liddle also says the markets are always overvalued by some measure. On March 23, 2020 for example, the S&P 500 hit a four-year low because we were at the start of the COVID-19 pandemic.
“Many considered the market to be overvalued because you could not accurately project the future income of companies in the market,” says Liddle. Since that day, however, the market is up over 80%.
Even ‘experts’ fail to time the market
Financial advisor Loren Sherman of Integrity Wealth Management says that beating the market involves “being smarter than the high-tech computers working 24/7, making milli-second decisions all hours of the day.” We also have to be smarter than expert investors brought in by top investment firms, as well as mutual fund managers who try to time the market as their life’s work.
But even for people who invest as their job, timing the market rarely works for long. In fact, research from the American Enterprise Institute (AEI) shows that over a 15-year period, 92.43% of large-cap managers, 95.13% of mid-cap managers, and 97.70% of small-cap managers failed to consistently outperform their benchmark index.
What to do instead of timing the market
While buying low and selling high seems like a solid investment strategy, most of us do not have the knowledge or time required to wind up ahead on a consistent basis. Financial advisor Jeff Rose of Good Financial Cents also points out that most people don’t have the necessary resources to monitor a stock all day and buy at the most perfect time, let alone strike while the iron is hot and sell for maximum profits.
“With careers and families to tend to, trying to time the market is a tall ask and why many investors are better off letting professional money managers do their thing,” says Rose.
Instead of trying to guess when you should buy and sell for optimal results, many experts suggest a different approach known as dollar-cost averaging.
“Dollar-cost averaging is the policy of investing at frequent intervals, such as a set amount every paycheck for 20 years,” says Anthony Montenegro, creator of the 401(k) Wealth Guide and founder of The Blackmont Group.
The major benefit of dollar-cost averaging is the fact that you take the emotion out of investing while paying a lower cost for shares over time. This is due to the fact you are buying fewer shares when prices are high and more shares when prices are low.
The good news is, most employees use this method when investing in their 401(k) plans, notes Montenegro.
“They will do better investing over a long period of time and gain more in compounded returns than if they take short-term bets on the latest speculative fads,” he says.
By Holly Johnson
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