Many investors buy into and sell out of the market more frequently than they should. They are trying to “time” the market. If you have never heard of market timing before, it is described as trying to pick when the stock market has hit a top or a bottom, and then buying into or selling out of the market accordingly. For example, if you are predicting that the market has hit the peak of the cycle, then you sell out of your holdings because the market has nowhere to go but down. Conversely, if you think the market has bottomed, meaning it won’t go any lower, then you invest all of your money since the market can only go up.
The Problem With Market Timing
There is only one problem with timing the market: it can’t be done. Just like no one can predict the future, no one can predict when the market will hit its peak or trough. Because of this, it is best to stay invested in the stock market. By staying invested for the long term, you guarantee that you will never miss out on the days when the market is rising. You may not think this is a big deal, but it is.
How Much Market Timing Costs You
If you had invested $1,000 back in 1970 and left it alone, meaning you were fully invested in the stock market until the end of 2011, it would have grown to $50,662. Compounded annually, that is a 9.8% return. But, had you missed the best day during those 40 years (yes, one day only) your $1,000 would now be worth $45,431. That is a 9.5% return. One day out of the market cost you over $5,000.
Let’s say you pulled your money out for a while and ended up missing the best 25 days. What would your $1,000 look like today? You would have $12,068, which is a 6.1% return. While this doesn’t sound too bad, thit is a difference of close to $40,000!
Some may say that by staying in the market full-time, you are guaranteeing yourself of taking the losses when the market drops. This is valid and very true. When you are invested for the long term, you will be invested on the days when the market drops. But look back at the picture. The highest return you could have earned, 9.8%, is the result of being invested in the market, when the market is rising and falling. Remember, you cannot pick the days the market will rise, so you cannot pick the days it will fall either. The chart shows that even experiencing a falling market, you will still come out ahead by staying invested.
Most investors pull out of the market after it has already dropped significantly and resist getting back in until after most of the gains have occurred. This is why most investors return on their investments is much lower than they think.
Trying to pick and choose the days you are invested is a guessing game that can cost you a significant amount of money over time. Don’t gamble with your money by trying to time the market. Stay invested over the long term and guarantee yourself that you will take advantage when the market takes off.
[Photo Credit: Sam Howzit]
Hi, my name is Jon and I run Compounding Pennies. I’ve been interested in personal finance since high school and love writing and talking about it. You can learn more about me in the Authors section of this site.