Is Timing the Market a Good Idea?

 

You hear it regularly online: “I have money to invest. Should I wait for the market to drop a bit before I buy?” While this question is understandable – we all want a good deal – my answer is almost always the same.

No. You shouldn’t wait.

The reality is that timing the market almost never works in the investor’s favor. The reason is simple: past performance is not necessarily indicative of future performance.

We all want to build massive wealth, but predicting what individual stocks will do is incredibly difficult. For most of us, it’s best to use a proven strategy and build wealth over time.

The main topic in this post, though, will be the reasons why timing the market can wreak havoc on your portfolio.

Timing the Market vs. Time in the Market

If you’ve ever heard this phrase before, the person who said it was giving you some good advice. Indeed, for most investors, time in the market beats timing the market.

In case you aren’t sure what this means, it’s simple.

Timing the market means attempting to only buy stocks when they are down and only sell stocks when they are up.

Time in the market means investing for the long run. You don’t pay much attention to your day-to-day returns and invest passively over a matter of years or even decades.

There are some investors who are able to successfully time the market; namely, day traders.

But if you don’t intend to make day trading a full-time or at least a part-time job, time in the market is your single most powerful investing weapon.

Remember what I said in the intro – past performance is not necessarily indicative of future performance.

For certain stocks, that may be the case. However, past performance is not nearly predictive enough to base buy and sell decisions on it.

Oftentimes, stocks or even entire funds may be on the rise, only to come tumbling down. The opposite can happen, too.

But here’s what we do know: over its entire history, the stock market always increases in the long run. It has certainly had its ups and downs, but over a 100-year period, it continues to show a positive trendline.

And those ups and downs explain perfectly why time in the market beats timing the market. Although the market has seen many recessions and even a few depressions, it has still increased in the long run.

Timing the market is extremely difficult, but your money is likely to grow if you invest for the long haul.

Buy and Hold or Index Funds?

We’ve established that investing for the long haul is ideal for most investors. That’s probably why there is a large cohort of investors who swear by investing in mutual funds and index funds.

This does work well for the average investor who has a busy life and doesn’t have much time to manage their portfolio. Still, some investors like to avoid the “losers” index funds may contain.

To be clear, your typical index fund is going to do well in the long run, regardless of stocks that may underperform. But some investors like to maximize their returns by avoiding those losers, if possible.

Of course, that is easier said than done. Separating the winners from the loser isn’t always easy.

To get help with that task, some investors subscribe to services like The Motley Fool Stock Advisor. I personally like to use The Motley Fool’s Stock Advisor in conjunction with M1 Finance.

In doing so, I am able to use their long-term buy-and-hold recommendations without having to check my portfolio frequently. Once you set your allocations on M1 Finance, you can set up auto-invest so it runs on auto-pilot.

Checking Performance Can Hurt Your Portfolio

The human mind is a funny thing. We may be the most intelligent life on the planet, but the way our brains work it’s always rational.

Betterment explains in its article on this topic that we react more strongly to bad news than we do to good news.

In other words, if our portfolio is doing well, we don’t have a huge reaction to it. But if things aren’t going so well, we can start to panic.

“Sell! Sell! Sell!” as Jim Cramer might say.

But remember the previous section: the market tends to increase in the long run. If we sell based on those temporary dips, we inevitably lose out on the growth that comes when the market goes back up.

And I haven’t even mentioned the unnecessary gains tax you’ll get when you sell reactively.

The other side of the equation is also true: if you want to invest in the stock market but are “waiting for a dip,” that too is the wrong way of thinking. There’s a good chance the stock will simply continue to climb.

Or maybe it dips for a day or two before going back up again. If you miss that window, you’re out of luck.

I’m once again going to give a nod to Betterment, who helped illustrate why checking your portfolio often is bad.

They pointed out that checking your portfolio daily will result in a loss of value 50% of the time. Checking once a year has a 25% chance, and checking once every seven years drops the chance to less than 1%.

I was confused when I first heard this – until I thought about it. See, each percentage is the chance your portfolio will have dropped over that entire time period – one day, one year, or seven years.

This makes complete sense since, as I keep reiterating, the market always goes up over time, despite temporary drops.

As you can see, trying to time the market is incredibly difficult. Plus, the market goes up in the long run, so for most of us, it’s best to avoid market timing altogether.

Stick With What Works: Long-Term Investing

If you are dead-set on trying to time the market, I probably can’t stop you. And as I said, there are some investors who do benefit from it, such as day traders.

But if you aren’t buying and selling stocks numerous times throughout the week, the reality is that your best bet is not to overthink it.

Whether you decide to invest in index funds, use a robo-advisor, or buy-and-hold individual stocks, these are all time-tested and proven strategies.

Of course, there is no reason you can’t do more than one of them. Even if you are buying and holding many individual stocks for years, this can be a more volatile strategy.

Thus, you may want to combine it with a robo-advisor or index funds.

Whatever you do, stick with what works. Don’t reinvent the wheel, and don’t overthink it.

And, yes, in most cases, that means avoiding market timing. For most of us, it’s best to stick with what works.

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