What happens when you try to time the market?
Smooth The Road: Plan & Invest. Edition Five, November 2022.
Seeing the news and how the financial commentators provide their analysis, be it about the rising interest rates, supply chain issues, or the prospect of the economy going into recession, many mum and dad investors are deciding to take a step back and reassess. Is now really the right time to invest?
So let’s say you've met with a financial adviser, discussed the options, and decided on an investment strategy. Now it's time to invest.
With all the information received, the overall market prices might further decrease. Right?
So, should you invest now, wait, or dollar cost average into the market (put a smaller amount in your portfolio on a regular basis)?
Let’s look at a test by the Charles Schwab Corporation, who had compared 5 investing styles as below:
Consider five hypothetical investors all with different investment approaches, regarding timing their investing.
The following investors all had $2,000 at the beginning of the year to invest in the S&P 500 Index, for 20 years ending 2020.
1. Peter Perfect
Peter was extremely lucky as he had timed the market perfectly every year. (What are the chances of that?)
He waited and invested the $2,000 at the lowest point of each year. For example, in 2001, he invested in the S&P 500 on September 21, 2001 – the year’s lowest closing level.
2. Ashley Action
Ashley took immediate action, where she invested $2,000 in the market on the first trading day of the year.
3. Matthew Monthly
Matthew splits his $2,000 into 12 equal portions and invested each portion at the beginning of each month.
4. Unfortunate Umbridge
Ms. Umbridge had poor timing in investing in the market. She invested $2,000 each year at the market’s peak every year. (What are the chances of that?).
For example, in 2001, she had invested her $2,000 on January 30, 2001 – the year’s highest closing level.
5. Larry Linger
Larry anticipated purchasing when the market further plummets, however, decided to pull the handbrakes when the market prices went back up. He was convinced to keep his capital available to purchase stocks at lower prices that were just around the corner.
Larry eventually did not invest in the S&P 500 and invested in Treasury bills each year.
A study from Schwab Center for Financial Research found that in a span of 20 years from 2001 to 2020, Peter Perfect, who perfectly timed the market had the greatest return, while Ashley Action, came second, followed by Matthew Monthly, Unfortunate Umbridge, and lastly Larry Linger.
Source: Schwab Center for Financial Research. Invested $2,000 annually in a hypothetical portfolio that tracks the S&P 500® Index from 2001-2020. The individual who never bought stocks in the example invested in a hypothetical portfolio that tracks the lbbotson U.S. 30-day Treasury Bill Index. Past performance is no guarantee of future results. Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly. The examples are hypothetical and provided for illustrative purposes only. They are not intended to represent a specific investment product, and investors may not achieve similar results. Dividends and interest are assumed to have been reinvested, and the examples do not reflect the effects of taxes, expenses, or fees. Had fees, expenses, or taxes been considered, returns would have been substantially lower.
The difference between the first and second place is $15,920. While timing the market would be the most apparent approach, it is near impossible to time the market consistently over a long period of time.
Let’s take Covid’s recent impact on the market for example.
29 December 2019 - Chinese authorities advise the WHO of cases of pneumonia of unknown cause, originating in Wuhan, Hubei province.
9 - 15 March 2020 - Stock markets crashed after instability due to the pandemic. What some labeled as "Black Monday 2020" was, at that time, the Dow's worst single-day point drop in U.S. market history. Also, S&P 500’s lowest closing in 2020.
23 August 2020 - The losses from this record-breaking crash were fully recovered by 23 August, only five months after the market bottomed and while the global economy was still deep in a quagmire.
Timing the market requires an investor to preempt that once the news about Covid-19 broke out in December, the markets will go down. They actually went the other way for more than a month, before the sudden drop, through to mid- February when they reached their lowest point.
An investor who attempts to time the market not only had to predict the direction and movement of the market, but they also needed to pinpoint the lowest closing day of the year, consistently, which is extremely unlikely.
Timing the market requires an extensive time commitment, knowledge, and a large degree of luck. Because many investors are occupied with work, family, and other pursuits, they might not be able to invest at the lowest point of each year. Hence, investing immediately, or to dollar cost average is a more realistic approach to investing.
In the long run, it is better to be investing, even at the worst timing, than to not be investing at all.
This newsletter aims to help New Zealanders on the path to financial freedom with tips and tricks from the professional financial planning process. Stay tuned for more handy insights and knowledge.
If you're ready to take the next step and want to look at how working with a financial adviser for your planning and investment needs may benefit you, please reach out for an initial no-obligation chat - I would love to hear from you.