Should you snooze on timing the market?
In last week’s post, we discussed how market volatility can be beneficial to your investment portfolio if you capitalize on the dips in the market by buying stocks “on sale”. (If you haven’t read that, you can find it here.) In that post, I gave the example of a pair of Nikes going on sale for 20% off, and we concluded that you would obviously want to buy the Nikes on sale as opposed to at full price. When the market declines and stock prices go down, the same principle applies, and you want to invest at the lower “sale” price.
To get the highest possible return on your investments, you need to invest at the lowest price, and sell at the highest price. Trying to predict future prices to perfectly time your buy or sale is called timing the market. Sounds simple enough, right? WRONG!
A few months ago, the panic surrounding the novel coronavirus caused investors to liquidate their investments, and stock prices plummeted. A large scale sell-off, like the one caused by the coronavirus, decreases stock prices because the selling of shares signals that investors think stock prices are about to decline, and they are trying to sell their stocks at the highest possible price in order to receive the largest possible return. When other investors see this, they also want to sell at the highest possible price, so they then sell their shares, which further devalues the stock, and the trend continues. The algorithms that are now used to buy and sell stocks further complicate this, but that is a topic for a whole different post.
With stocks plummeting, it now becomes a buyers market. But how will you know when the sell-off stops and the stock is at its lowest price? Bad news, you won’t. In these scenarios, unless you are lucky enough to be the first seller before the price drops, or the first buyer before the price starts to increase, you didn’t time the market properly. While sales on goods usually have a defined start and end date, as wells as a defined discount, the stock market is not as transparent. Timing the market to wait for stocks to be at their lowest price to buy, or highest price to sell, is nearly impossible. On top of that, the amount of anxiety you will feel trying to make these decisions will be paralyzing.
To avoid the anxiety around picking the perfect time to invest, and usually failing, I recommend using a long term investing strategy with a phased in investing approach. So how do you do this? Let’s say you have $1,000 you want to invest. Instead of trying to pick the perfect time to invest all $1,000, you could invest $200 over the next 5 weeks, or $100 over the next 10 weeks, or $200 over the next 5 months. You get it.
This approach helps mitigate any losses you may experience from a down period that occurs after you make your investment. Since market volatility is just that, volatile, you may think the stock is beginning to rebound only to see it drop significantly again. If you phase your investments in and invest the $200 over 5 months, you will only experience a loss on the portion of your $1,000 that you’ve already invested, and you will be able to capitalize on investing the rest of the $1,000 at the now lowered price.
Take a look at the table below.
|Approach 1||Approach 2|
Approach one uses a lump sum investment, and approach 2 uses phased in investing. You can see that if the market continues to decline and you use a phased investing approach, you will be able to capitalize on the decline in prices, and have higher returns at the end of the down cycle.
The downside to this approach is that it also works in the opposite direction. So, if you phased your investments in during an increase in the market, this would have the opposite affect on your investments, and the lump sum would give you the higher overall return. Let me be clear that using a phased in approach and making some investments at a higher price does not make these investments losses! Basically, this means you bought one pair of Nikes on sale, and the next pair at full price. In both cases, the Nikes are still well worth the money, you just got a better deal on the first pair.
Since it is so hard to time the market, and nearly impossible to predict what will heavily impact it (did you see the coronavirus coming?), minimizing your stress about investing, while making smart decisions to create a generous return for yourself is ideal compared to trying to perfectly time the market, failing, and not investing at all or losing money by paying a financial advisor to do it for you. (News flash, financial advisors also didn’t see the coronavirus coming.)
To minimize your stress, set up an investment account and make small, regular investments over many years. This allows you to use the higher returns you will receive from investing during a downturn (sale pricing), to compensate for the higher prices you will invest at during the up swings (regular pricing), all while never having to worry about what the stock market is doing. Pick an amount of money that fits your budget, and auto invest it at regular intervals. This is an easy and worry-free long term investing approach that anyone can start today.
Now that you’ve set up your investment strategy, you will need to decide what you will invest in. And you guessed it, that’s next week’s topic!!