So, is now a good time to invest? Or is the market overvalued?
Hmm, maybe I should wait until it bottoms out again. Buy low, sell high, right?
**Deep sigh**
How many times do you ask yourself questions like these?
Personally, I’ve lost count long ago.
Timing the stock market is one of the hardest things to do in the world of investing. Sometimes I nail it, other times, I’m kicking myself for missing my moment.
In fact, timing the market is so hard that only a very small fraction of people are able to do it profitably for an extended period of time.
That explains why the American Enterprise Institute found that fewer than 5% of professional money managers outperform the stock market.
But why is that?
Today we’re going talk about why trying to time the market is a losing proposition, and what you can do instead to ensure you get the best balance of higher returns with lower risk.
If you’re tired of second guessing yourself when making an investment, or find yourself scanning stock charts trying to predict what’s going to happen next, it’s time we had a chat.
Timing the Market is a Fool’s Game
If you’ve stumbled on my rant about the folly of buying individual stocks, you’ve hopefully come to your senses and now only invest in broad, low-fee, highly-diversified, market-tracking index funds. If you haven’t, I highly encourage you check that out.
In that piece, we also discussed what makes stock picking so hard.
In a nutshell, it comes down to the randomness of life.
We can barely predict what’s going to happen to our lives and our careers in the next few months, much less years.
If we can’t make a confident prediction about ourselves, for whom we have the most comprehensive information possible, how on earth are we supposed to make an accurate prediction about another company, industry, or the world as a whole? Especially when our information on those sectors is far less complete.
This exact paradox is what makes timing the market near impossible.
Could you have predicted that in 2020 that the US economy would go from “full steam ahead” to a retraction of 33% in the second quarter, which by the way, is more than the 26% plunge during the 1929 Great Depression?
And despite that massive contraction and global turmoil, within a few short months, the stock market would reach a new record high, marking the fastest turnaround in the history of the stock market?
In the first half of that year, hedge funds and institutional investors made, and lost, billions of dollars in profits, each placing different bets on what was going to happen next.
But none of them knew what the future held. If they did, they’d be the only shop in town.
We, as individual investors, also don’t know what the future holds.
That’s why the smart ones among us stick with broad, diverse index funds.
The only bet we’re placing is that, as a species, humanity will continue to get better at building stuff and doing things through new technologies and a growing pool of shared knowledge.
That translates to individuals enjoying ever-increasing standards of living, and ultimately companies and industries making more money, as those individuals put their growing wealth to work.
We, as intelligent Wealth Stakers, with our hands in all the honey pots at once, profit from all of that.
When Good isn’t Good Enough
But even the smartest among us get impatient.
We know that, despite the short-term fluctuations we see during economic turmoil, if we just sit tight, our diversified investments will, over time, march steadily upwards, to the tune of nearly 10% annually, before inflation.
But that knowledge doesn’t stop us from wanting to juice just a few more percentage points out of the process.
Ten percent is great and all, but what if we could twist a few dials to get that up to 15%?
What if all we did was hold on to our next chunk of cash until the market dipped by, say, 2%. As soon as it did, we’d snap up our shares while prices were low.
Sounds easy enough.
And if we pulled this stunt just a few times a year, we could easily eek out an extra 5%.
And look, we’re not trying to be greedy here, but 5%, compounded annually for 15 years, is a 100% boost. That means if we invested $10,000, our ending balance after 15 years would be over $80,000, rather than a measly $40,000.
Who doesn’t want an extra $40k to put to work?
The problem is, getting that extra 5% is insanely hard. It’s hard for all the reasons we just discussed.
Still don’t believe me? Fine, let’s play this out.
You say you’re going to hold on to your cash until the market dip of 2%. But when, pray tell, is that dip? Is it tomorrow? Next week? Next month?
If the dip isn’t until next month, what’s your cash doing for you in the meantime?
Sitting collecting dust.
In fact, it’s doing worse than collecting dust. It’s actually losing value, because even if it’s sitting in a savings account, it’s almost certainly yielding less interest than the rate of inflation.
In other words, each day, your dollars sit in cash form, they’re worth just a little less than they were the day before.
And even if you got a great deal on a high-yield interest account, it’s certainly not benefiting from the all stock market growth and dividend paying going on while you’re waiting for your “inevitable” dip.
So you’re holding on to the cash, which is losing value due to inflation and opportunity cost, and finally, two months from now (so much for that one-month prediction), the market pulls back 2%.
Boom! Time to put your plan into action.
The only problem is, during that two-month period, the stock market grew quite a bit. In fact, it grew by a total of 5%. So even though you got your 2% dip, it’s still 3% higher than when we started.
In other words, when you finally make your strategic purchase, you’re actually paying a 3% premium over the price you would have paid if you hadn’t waited.
So much for buying low.
This exact scenario we just went through happens all the time. There are hundreds of three-month periods in the last few decades that play out in a very similar fashion. In many cases, it’s even more extreme.
So why does this happen so often? Have you figured out the fatal flaw?
Here it is: over time, the market goes up more often than it goes down.
What this means is that when you bet on it going down, your odds are worse than when you bet on it going up. And remember, it’s always a bet. Neither you, nor Warren Buffet, knows for sure what’s going to happen.
None of us knows when the next bat, pangolin, or camel is going to send the world into yet another crisis and totally rain on our stock-timing parade.
And sure, during those periods of strife, the markets go down.
But inevitably, over a 5 to 10 year period, certainly over a 20 year period, you can be pretty darn confident that market’s going to go up a whole lot more than it goes down.
An Alternative to Timing the Market
So if we can’t time the dips, what do we do instead?
It’s actually astonishingly easy. We simply bet on the market going up. Always.
What does this mean in practice?
Invest whenever you have spare cash to invest.
Don’t wait. Don’t guess. Don’t get clever. Just invest.
Now I get it. There are times when this is insanely hard to do.
When the stock market is at all-time highs, it’s really hard to say to yourself: I’m going to pay 5% more for these shares, and the price is probably going to go down for the next few months, but I’m going to buy anyway.
But that’s exactly what you have to do.
Because it may go down next week, and the next, and the next, but eventually, over time, it’ll go back up, and soon enough, its value will far surpass the price you paid for it.
And even when the price is going down, you’re still collecting dividends these companies are paying out quarterly.
You might have heard of something called “dollar cost averaging”. That deserves its own discussion, but the concept is similar. Invest at regular, fixed intervals, without any regard to how the market is performing.
If you have a steady paycheck, dollar cost averaging is a fantastic way to go. Just allocate a percentage of your take-home pay in each paycheck to be invested into your brokerage account.
If you don’t have a brokerage account yet, I highly recommend Wealthfront or Betterment.
Both of these platforms make it super easy to get started. They offer a fantastic blend of diversified, low-fee, market-tracking index funds. And they customize your allocation based on your age and financial priorities.
My favorite part is that you can set up a recurring investment that pulls from your bank account every time you get a paycheck.
Now, if you’re like me and are self-employed, you don’t necessarily have the flexibility to invest at regular intervals.
My cash flow is all over the place. Sometimes I have a surplus, sometimes I’m in crunch mode.
In that case, the key is to have a good understanding of how much cash you need on hand for your monthly expenses. You can then tell Wealthfront or Betterment to only make an investment when your bank account balance exceeds that threshold.
That way, it’s still automatic, but it won’t pull cash from your account when you’re below your threshold.
In other words, with these platforms, you can dollar-cost average without lifting a finger. And since it’s automatic, you don’t have to have that painful psychological battle with yourself about market timing. The money gets invested without you even thinking about it.
I’ve invested with both Wealthfront and Betterment for years and can say they are equally excellent. You can’t go wrong with either. If you’re like me, go with both.
I’ve included links to both platforms here:
Wealthfront: https://wlth.fr/2nDlE15
Betterment: https://betterment.com/?referral_key=gregoryroot
You and I both get a referral bonus when you sign up, which helps support what we do here at Stake Your Wealth.
One Caveat
One important caveat to this investing approach, is that it requires you to have a 10+ year withdrawal horizon. You need at least that much time to weather the ups and downs of short-term market fluctuations.
So if you expect to be withdrawing large portions of your brokerage account sooner than that, say for retirement or a down payment for a house, you can still apply the same principles, but make sure your investment portfolio is at a much lower risk profile. Think municipal bonds, treasuries, and Certificates of Deposit.
With this more conservative approach, you’ll get less upside, but if you need to make that sale during a downturn, this will mitigate your losses.
And it’s worth noting that Wealthfront and Betterment actually allow you to adjust your risk profile, in the way we discussed, with just a few clicks.
Your Key Takeaways
Okay, let’s wrap up there for today.
Remember, the market goes up more than it goes down. That’s why trying to time the dips in the market is a losing proposition.
As the saying goes, “It’s not about market timing. It’s about time in the market.” That’s the key takeaway.
You don’t get rich from investing in the dips. You get rich from putting your money into the market as soon as you can, and then letting the relentless progress of humanity build your wealth for you.
Don’t wait for the next pullback or correction. On average, sooner is always better than later.
So, if you’ve been holding on to a chunk of change, waiting for the perfect time, let me put you out of your misery: the time to invest is now.
