It’s not unusual to hear about the stock market’s performance on the news or in your daily conversations.
The markets went up, or they went down, or someone thinks they’re going to go up or down, and paying attention to the news isn’t a bad thing. But beyond listening to your coworkers gossip about their stock picks, should you try to invest at the “right time” in order to boost your portfolio?
The short answer is no.
Why not? Here are the highlights.
- The stock market is unpredictable in the short term, and even the pros can perform worse when they try to time the market.
- Making decisions based on your emotions can cause you to buy high and sell low, which is the opposite of a good strategy!
- History shows that investing your money regularly is your best bet to see returns over the long-term.
Figuring out the right time to buy or sell is called market timing, and it’s something that even the pros don’t get right most of the time.
In one study, they found that when professional money managers tried to time the market, it resulted in worse performance than if they had just stuck to the original plan.
So if market timing is hard for people who spend their entire day, and years of studying the market, how is anyone supposed to keep up? The good news is, you don’t need to.
Timing the Market Can Tank Your Returns
Here’s a fun fact about the markets that you might not know.
Everyone likes to talk about annual returns, but those numbers are usually driven by a handful of very good days during the year. If you’re trying to time the market, you’re likely to miss those days, and the gains that come with them.
Here’s a tale of two portfolios to help show you what a big impact those few great days can have.
Susan and Mark both invested $100 in the S&P 500 in 1997.
Over the next 20 years, Mark tried to time the market, and missed out on the 20 best days. That’s about one day a year, so it shouldn’t have a big impact, right? Meanwhile, Susan stayed invested, and kept her money in the market the whole time, including those 20 great days.
In 2017, Mark’s original $100 had grown to $125.70.
Susan’s original $100 had grown to $401.35.
The only difference between their two portfolios is that Mark happened to miss out on the 20 best days of market performance over a 20-year period.
The Market Is Unpredictable (In the Short Term)
It’s easy to talk about the days when the market makes big gains, but what about the big losses?
It’s not uncommon for the markets to drop 10% to 15% in a short period of time, and when they do, oh boy is it ever tempting to sell and hold on to what you still have left.
On the flip side, when everything you see on your social media feeds is talking about a major boost to the market, it’s easy to want to get in while it’s on the rise!
But both of those actions—selling after a loss, and buying on a high—are the two things that can seriously tank your returns.
You’ve heard of buy low, sell high, right? Well, when we try to make complicated investment decisions to beat the market, we’re likely to do the exact opposite.
That’s because we all have behavioral biases. Some biases, called emotional biases, are based on our feelings and emotions. For example, the status quo bias causes us to overvalue our current situations and previous decisions.
Cognitive biases are hard-wired into our brains, and they’re designed to help us make quick decisions based on the information we have available. One bias in particular, the recency bias, explains exactly why we’re so bad at buying low and selling high.
The recency bias makes us think recent events are highly likely.
If the markets are falling, we’re likely to think they’ll keep falling—that’s why we’ll decide to sell low on a bad day for the markets. When the markets are going up, we think they’ll keep going up, so we buy high.
So What’s a Regular Investor to Do?
You want your investments to go up, just like everyone else. If you can’t count on market timing to do that for you, what should you do instead?
1. Invest regularly, and often.
Pick a specific amount you want to invest, and a monthly frequency to invest, like $100 per paycheque.
By putting your money into the market in smaller amounts, at regular intervals, you’re putting one of the smartest long-term investing strategies to work automatically: dollar cost averaging.
Dollar-cost averaging is when you use a fixed dollar amount to buy the same investments on a regular schedule, no matter what they cost.
If the markets happen to be down on the day you buy, you’ll score more of that investment for the same dollar amount, which balances out buying when the price is higher—and lowers the risk of buying only once at a specific time.
2. Develop and stick to a plan for all your goals.
Instead of thinking of your savings as a big pile of non-retirement cash, break it up based on how you want to use the money.
That way, if one of your accounts does see a 10% drop, you’ll be clear on how it affects that goal, and you won’t have to panic about how it impacts the rest of your financial life.
3. Keep a cash emergency fund.
Not all of your money has to be invested, and having a stash of cash that just sits in an account can actually make you a better investor.
It’ll protect you from the temptation to sell low if you need to have a certain amount of cash on hand, and you’ll know for sure that your accounts won’t ever dip below that amount.
4. Plan for risk as part of investing.
If you’re saving consistently for something you need to buy on a specific timeline, consider opting for a less risky portfolio for that goal.
Think of it this way: a wedding in a year might be a low-risk investment portfolio, because you need to have that money to pay for it.
A dream vacation in five years, on the other hand, can withstand a bit more risk because you can always adjust your plans when it gets a bit closer. No one books flights 5 years out, after all.
Don’t Try to Time the Market
It’s easy to get sucked into the temptation of higher returns if only you could just pick the winning stock, or the right time, or even just figure out when those best 20 days will be.
However, over the long term, evidence suggests that timing the market doesn’t work for everyone: not for the investment pros, and not for casual investors.
When it comes to finding the best returns, slow and steady really is your best bet. Set up an investment account (which you can do quickly using Twine!) invest money on a regular basis, and watch your money grow.
That way, you won’t miss out on the great days for market growth, and you’ll dollar-cost average your way through any slower periods.
Investing 101: Let’s do this
Investing doesn’t have to be something scary and intimidating, and it’s one of the most powerful ways you can hit your goals and build wealth over the long term.
Make a Plan:
- Should I Save or Invest?
- Understanding the Stock Market
- Long-Term Investing
- The Relationship Between Risk and Return
- Investing for Beginners
- The Benefits of Diversifying Your Investments
- Types of Asset Classes
- 5 Common Investing Mistakes
The S&P 500 Index has been used as a representation of the markets.
Hypothetical example for illustrative purposes only.
Source: Morningstar Direct, S&P 500 Total Return Index.
Assumptions: One-time investment of $100 on Dec. 31, 1997 in the S&P 500 Index. For market timing examples, the 20 highest single-day returns were removed from the total return. Indexes are unmanaged and cannot be invested in directly. You should always keep in mind though, that you can’t count on the market to behave the same way in the future as it has in the past. These comparisons, while a helpful way to evaluate your investment options, should not be considered predictors of future performance.