Timing the Market is Hard. But…Here’s How I Do It!
The recent market volatility relating to Covid-19 has been difficult. In the longterm, I am optimistic that the economy will recover and stock prices will rebound. Another decade from now, I bet this period will be looked back on as a good buying opportunity that developed amidst a horrible global health event.
In the short-term, the stoppage of large parts of the economy and even shutting down all production in parts of entire countries, is scary. Most people I know have been affected by the virus. Many are either laid off, some are furloughed, and most have at least had hours cut. Despite being an “exempt worker,” my hours and pay have been reduced as well. We just don’t have the volume to necessitate our typical staffing.
The stay-at-home orders seem to be working to flatten the curve. Fortunately, no one in my immediate group of family or friends has had their health affected or been hospitalized from the virus.
Being a financial blog, the question is how long before our economy can be reopened…should we sell everything and wait for the economy to turn around before starting to invest? At some point, regardless of the virus, our economy WILL have to be reopened. If it is not, then people will be unable to pay their bills, resulting in ripples across even more aspects of the economy.
I started this blog in July 2010. Prior to then I was either in college or medical school and was spending tuition money rather than having any left over to invest.
I’ve been investing nearly every month since then and have benefited from the past decade of a bull market. While I give at least a cursory look at the markets everyday, I have prided myself on not making rash choices. The worst thing that you can do is to react to the daily fluctuations. Other than short term drops here and there, e.g., the Flash Crash of 2010 and the 11% drop in December 2018, the Covid-19 economy and stock market is my first real glimpse at a recession that I’ve experienced first hand with skin in the game.
When the economy is moving along smoothly and stocks are going up-and-up, everyone wants to invest. There is a good analogy that I like to give to friends that are just learning about investing.
Imagine going into a grocery store and seeing your favorite food on sale. You’ll buy up a bunch extra, right? That should be the same general concept for stocks. Your favorite stock drops in price and you happily buy more. To use the food analogy, why do many people think that they should buy more of their favorite food when it goes up in price?
When it comes to stocks, people react differently. I don’t know why, but it is likely coming from a psychological basis. The constant barrage of scary headlines on TV and online probably plays a huge part. See bullet point #3 below.
Back to timing the market.
Yes, if you could have predicted the 30% decline followed by the 20% gain (just in the past month!), you’d be far better ahead. However, predicting that is impossible and anyone that did sell and buy at the correct time was nothing more than extremely lucky.
If you want to sell an investing newsletter, I have an excellent strategy for you that is sure to get some fervent believers. Pick a crazy stock idea. Tell 1000 people to buy it and 1000 people to short it. Tell the group that was correct another idea, splitting the group in half. Keep this up and pretty soon you’ll have a few dozen people who are absolutely impressed at your godlike ability to correctly pick 6 consecutive stocks! Then you profit by selling this group your newsletter for a bunch of money. Once you know how this newsletter strategy works, you’ll understand that accurately timing the markets are impossible without illegal insider information.
According to a study from Fidelity, if you had been invested $10,000 in the S&P 500 on January 1, 1980 and held through the end of December 2018 (which includes the 11% drop that month), your money would have grown to $659,515.
However, if you decided to sell at some point and missed just 5 of the best days, your portfolio would have been worth a staggering 35% less and be worth only $426,993. Miss 10 of the best days and the portfolio is worth $318,036. Miss 30 of the best days and the portfolio is worth $125,080. Miss 50 of the best days and the portfolio is worth 91% less…$57,382.
There were around 10,120 trading days during this time period. Miss out on less than two months of the best days and you miss out on the huge majority of what your portfolio could have been worth. For those that are counting, less than 0.5% of the best days make up the supermajority of your gains. When the stakes are so high, do you trust yourself to time that?
Maybe you think I just have to miss the worst days. That should work better, right? The reasoning behind that is to come back to even after a 50% drop, you need a 100% gain.
Index Fund Advisors actually did the calculations for us. For a 20-year period from 1/1/2000 – 12/31/2019, missing just 40 of the worst days would have increased investment returns by a whopping 991%! However, to accomplish this, you would have had to pick the two worst days per year correctly — for 20 consecutive years.
Index Fund Advisors did a similar calculation as Fidelity but it documented missing the best days over the last 20 years and came up with similar results.
Dalbar released research that showed that the average American through the end of 2019 is underperforming the S&P 500 over the last 30 years. Over that period the S&P 500 returned an average of 9.96%, while the average stock fund investor realized annual gains of just 5.04% per year. Why is that? Aren’t we told to buy and hold a S&P 500 index fund? Why such a big difference? An annualized 4+% difference is huge! I bet it is people thinking that they can time the market.
Think back to the Global Financial Crisis (GFC) of 2008/2009. If you were one of the people that decided to sell, in addition to locking in those losses, what criteria would you have used to get back in? Would you have wanted to see a few months (or years) of good stock market performance? If you had, you’d likely have missed out on some of those best days.
Here is another graph from the same Fidelity article showing the subsequent 5 year returns from several of the largest market drops in history.
Looks like the moral of the story is to stay invested and maintain regular investing regardless of the conditions.
All this research leads to a couple of points:
- Do not invest money that you need in the next 5 years. That is approximately how long it took for the S&P 500 to recover from the peak pre-GFC level. See the chart below:
- Do not try to time the market. See all the red above? Those represent drawdowns of 5% or greater from the pre-GFC peak to Jan 2018. Despite the long bull market, we have had numerous drops throughout it. Do not react emotionally to these drops.
- Try not to listen too much to the news. If we wanted, we could have a constant background hum of the 24/7 news cycle. How much of that really affects us? The news companies jobs are to sell ads and make money. The best way for them to do that is by preaching scary headlines and getting us to click or to get as polarizing as people on TV as possible to capture our eyeballs and attention. This is all done for their benefit, not ours. The psychological effects on us have got to be very detrimental for our mental health. Think of Buzzfeed. They exist solely to get us to click on their headlines. We know exactly what they are and what they are doing, and yet we cannot help ourselves. We need that dopamine rush. In a way, the news channels are even worse since they claim to be impartial though they too rely on getting views. If you react to all the claims on the financial channel, you’d be too scared to stay invested since there is always some economic or world ending event that a guest will be talking about.
- Invest to your level of comfort. I’ll write a blog post about recommended allocations in the coming days, but essentially, you have to decide your personal risk tolerance. Everyone says that they have high risk tolerance when things are going good. The important thing is to choose a risk tolerance that you can handle when things get rough. A good question to ask is if the general market and a stock you own dropped 25%, what would you do? Would you sell all your shares, sell some, do nothing, or invest more? Would you buy more like it was your favorite item in the grocery store? If you say sell all your shares, you probably should not have that money invested in the first place. You have to figure out the allocation to your sleep well at night portfolio.
- The best time to invest is when you have the money. However, most of us would not feel comfortable investing a lump sum in such volatile times. A way to get around this but still stay invested is what most of us do in our 401k’s already — dollar cost averaging. Put a little in regularly each month. That way you will be happy regardless of what the market does. If it goes down you are happy you only put a small amount in and are looking forward to your money purchasing more next month. If it goes up you are happy you participated on the upside…had you decided not to invest at all you would not have participated in the gains. Dollar cost averaging is a technique to take some of the emotions out of investing.
Ready to Learn My Market Timing Secret?
I’m sorry to say that I do not have one! The “click bait” title is exactly the kind of stuff that triggers us to react whether we read it online, see it posted on FaceBook, or see and hear it preached by the pundits on TV. It leads to an unhealthy anxiety.
But, in the context of reading through this entire post, maybe it did work. If you read through this far, congratulations! Please leave some comments below.
Please stay safe and healthy. Use this time to stay home and be with your family and the ones you love. For those that live apart from their family, use this time to reconnect or just connect more frequently via FaceTime or the plethora of video chat services out there. A quick sidebar: I have become partial to Jitsi Meet, a free, open-source video chat service that works in web browsers (though Chrome/Firefox only) and has iPhone and Android apps.
6 tips to navigate volatile markets
Why Average Investors Earn Below Average Market Returns
Opinion: Americans are still terrible at investing, annual study once again shows
Market Timing: More Evidence Why It Doesn’t Work
No, You Don’t Sell Stocks During the Coronavirus Pandemic
Dalbar Inc., “Quantitative Analysis of Investor Behavior,” March 2020.