Timing the Market or Time in the Market?
6 min read
"The market is too scary for me right now. I'm going to wait for a better time to invest." - I hear this daily.
To keep this interesting, let's say four guys walk into a bar. They decide to play a game with the same goal. Invest the same amount of money for 57 years, and see who has the most in the end. Using market data tracking the S&P 500 spanning from 1963 through 2019, they begin to invest with various strategies.
Investor 01- Alan. His name is Alan, but we may as well call this man Cool Hand Luke. He is able to detach his own emotions from his money and is otherwise a disciplined investor. Consistently investing $100 at beginning of each year, and staying the course.
Investor 02 - Bob. The luckiest guy you've met in your entire life. Gets all the girls, homecoming king, this guy can't miss. His reward for being right? About 0.24% a year better than Alan.
Investor 03 - Charlie. The unluckiest guy you've ever met. He never seems to have anything go his way. His penalty for being seemingly jinxed? About 0.32% a year from Alan.
Investor 04 - Don. This is the smartest guy in the room. Or so he thinks. He puts his $100 at the beginning of each year the same as Alan, but he also tries to time to the market, getting in and getting out with his entire portfolio. Remember: he has to be right twice (once when he sells, and also again when he buys back in). Not taking into account the tax implications and trading costs, let’s just assume he misses out on ONLY the three best days each year. His portfolio is like a bar of soap; the more he touches it - the smaller it seems to get. Literally, he actually loses money- over 57 years he invests $5,700 and is left with $3,993. The lesson here is simple: have a disciplined approach, stay the course, and invest for the long term. Most folks don’t have to be the best investor in the world to achieve their goals, but they can’t afford to be bad investors.
Risk Tolerance vs. Risk Capacity
“It’s one of the ironies of investing. The rich can afford to take risks, but they don’t need to. The poor need to take risks, but they often can’t afford to. ”
There is a stark contrast between tolerance and capacity, and understanding the difference is crucial. Risk tolerance is just that - how much fluctuation in your portfolio can you tolerate without losing sleep. Conversely, risk capacity involves how much fluctuation you must endure en route to your financial goals. A customized approach ensures that these two parameters operate in concert with one another. There are different ways to calculate this, and any good advisor should help you figure it out.
The graphic above depicts the underperformance of the “Average Investor” compared to other asset classes. The return metric is calculated by essentially looking at the inflows (sales) and outflows (redemptions) of mutual funds each month and is widely accepted as a measure of investor behavior. Now let’s dive into why this might be the case.
Investment Discipline
In reality, most decisions to buy and sell are not made by investors in pursuit of outperformance. This irrational behavior of a long-term investor is typically made out of fear rather than greed.
Typical Investor: "I'm worried about ________” (insert concern: Covid-19, Presidential Election, Oil Prices, Tariffs, terrorist attack, etc.)"
Whether it be business, accounting, political, geographic, or government- the reality is, there is invariably an inherent risk to investing.
Your Advisor: “What concerns you most about (inserted worry)?”
Typical Investor: "I'm worried I will lose money." But going a bit deeper, the answer behind the answer is actually, "I'm worried that I'm not going to be able to meet my financial goals if my concerns come true."
I’ve learned that at its core, most investors are concerned with (inserted worry) is due to uncertainty. Naturally, we can be sure what the market does tomorrow or the next day will always be an uncertainty. So as opposed to focusing on that, it's best to focus on what we can control. That's why it is essential to have an investment discipline in place. We want to have something that will either protect against loss or capture gains, regardless of the market environment. Now, diversification is not an all-in or all-out type of decision. There is a risk tolerance spectrum that goes from very conservative to very aggressive, and we can pinpoint where you want to be (risk tolerance) and where you need to be (risk capacity). That way, even if we are uncertain about (inserted worry), we can find comfort in the certainty of our strategy.
Reasons Not To Invest
Let’s assume that you’re just naturally risk-averse and let every bit of toxic headline news over the last 30 years keep you out of the market. What would you have missed?
Keeping everything in cash might make you feel warm and safe. I won’t argue that cash is certainly king at making us feel cozy, but that might be the only thing that it’s king. Here’s why: even throughout all of the major reasons over the last 30 years to not invest, the benchmarks all yield unbelievable results. Your $100k of cozy cash is still cash, but it could’ve grown to over $900k in the S&P 500 up to almost $2Million in the Nasdaq!!
Don’t just take my word on why timing the market is a losing proposition.
“Only liars manage to always be out during bad times and in during good times.”
“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.”
“In the financial markets, hindsight is forever 20/20, but foresight is legally blind. And thus, for most investors, market timing is a practical and emotional impossibility.”
“I can’t recall ever once having seen the name of a market timer on Forbes’ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions doing it.”
“We have long felt that the only value of stock forecasters is to make fortune-tellers look good.”
“Do you know what investing for the long run but listening to market news every day is like? It’s like a man walking up a big hill with a yo-yo and keeping his eyes fixed on the yo-yo instead of the hill.”
“Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.”
“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
The bottom line & key takeaway is this: time in the market has proven to be much more impactful than timing the market.
Thanks for allowing me the opportunity to play a role in your financial success.
Stay the course,
