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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 1Approach 2
MonthMarket ChangeInvestedBalanceInvestedBalance
1-2% $1,000 $980 $200 $196
2-3% $-   $951 $200 $384
3-2% $-   $932 $200 $572
4-4% $-   $894 $200 $742
53% $-   $921 $200 $970

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!!

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Stocks On Sale!

You’ve probably heard that you should BUY! BUY! BUY! (*NSYNC voice) your stocks right now since the market is down. On the surface, this doesn’t seem to make any sense. Investors are losing money, so why should you put your money into something that is decimating others’ fortunes? I’m here to give you the DL.

I am a believer in the Efficient Markets Hypothesis. This hypothesis says that the market price of a stock reflects all of the available information about that stock. Basically, the market price is a correct reflection of all of the available information on the company, and unless you have insider information, you won’t be able to beat the market.

Warren Buffet is an example that this assumption is not always correct. You can find stocks that are undervalued and buy them at a low price. Later when the price goes up to reflect to true value of the company, you will make money and beat the market. So while it is possible to beat the market without insider info, it is only possible if you dedicate all of the time that Warren Buffet has to finding undervalued stocks. And even most of the financial advisors and fund managers who dedicate this amount of time, produce an average annual return on their hand selected funds that is equal to, or less than the average market return over the long term. If trained professionals rarely beat the market, and Warren Buffet is either the only billionaire investor you know by name or one of a few, my guess is that you will probably not be successful using this investing strategy.

So then the question becomes, how can you maximize your returns if you can’t beat the market? I have good news. The market, on average, goes up over the long term. There will be short-term peaks and valleys, and when stocks start to dip, investors’ instincts are to sell before they lose more money. But if you’re playing the long game, which I suggest you do, this makes little sense.

I’m 30, and I do a quarterly review of my financial situation. Each quarter since I’ve started doing this, my investments and net worth have gone up…until my April 2020 review. The coronavirus has caused me to lose money on my investments for the first time in my life.  But unlike many others, I didn’t sell off any of my investments and I’m not worried about them.

Unless you are near retirement, this dip in your investments is only a paper loss. A paper loss means that when you look at your account, the funds in your account are less than the amount you invested. If you withdraw the money, this becomes a real loss. Here is an example. Q1 2019 you invested $100. Q1 2020 you had $90 in your account. So after 1 year $10 is your paper loss amount. If you withdraw the $90 from your account, this loss will become a real loss of $10. Instead, you can leave the $90 in your account and wait for the market to improve over time, since as we learned earlier you should receive a positive return on the market over the long term.

On average, the market’s annual return before adjusting for inflation is about 10%. So in 5 years, your $90 should become about $145. This means you will have a paper gain of $45 above your initial investment of $100. While you will have to wait longer, if you withdraw your money after 5 years you will then have a real return of $45. If your retirement date is many years in the future, you have plenty of time to recover any losses you’re experiencing now. And this is why you should not sell off your investments or be worried.

Now that you have an understanding of why these dips aren’t as scary as they seem, we will discuss how you can actually benefit from them.

In Q4 2019, the market was up and had experienced its longest expansion to date. Everyone was making money and loving it. Let’s say for this example that the S&P 500 Index was trading at $100/share in Q4 2019. Then along came the coronavirus, which led to global shutdowns, the fear of supply chain disruptions, job losses, and stocks plummeting. So now with the coronavirus in full effect, let’s say the S&P 500 Index is trading at $80/share at the end of Q1 2020. The stock lost 20% of its value, but basically what this means is that the stock is on sale. (This assumption only applies to well-diversified portfolios, or index or ETF style funds. It can, but does not always apply to individual company stocks.)

Let’s take a look at a tangible example. If you want a pair of Nikes that retail for $100, and then buy them for 20% off during a sale, you would say you got a good deal on them. The same goes for stocks. Next week the Nikes will be priced back at $100, and next year the index fund’s price might be back up to $100, and in both scenarios it is best to buy at the sale price.

While the sale prices of goods are more transparent and well defined than stock prices, the principles behind buying at the lowest possible price remain constant. Timing the perfect buy is very challenging, but next week, we will discuss the process for investing during a downturn.

Read our next post in this series on timing the market.