The challenge here is you have to be right twice.
First, you have to know when to pull your money out. Even if you manage to be correct and avoid losses, you still have to be right a second time–knowing when to put your money back in. This second decision is even harder than the first.
Why? The market doesn’t give us an “all-clear” signal. Oftentimes the world still looks ugly when the market starts to recover. Buying back into this type of market is scary.
Why time in the market matters
What does it mean to focus on time in the market?
It’s simple—get money invested and keep it invested, regardless of the news or market forecasts. Since we’ve determined that timing the market is hard, this strategy makes the most sense.
Some will argue that timing the market, even without perfect foresight, still makes sense. After all, making a move to avoid some losses is still worth it, even though we might get back in a little late. The problem with this thinking is that it ignores market history. Some of the best stock returns happen in the depths of a bear market and subsequent recovery. Missing out on these days eats into your returns.
For the 15-year period ending December 31, 2020, the S&P 500 returned 9.88% per year. However, missing out on the best 10 days cut the return to only 4.31% per year. Though the market requires long-term time horizons, these numbers show that a small number of days provide outsized returns.
How can you ensure that you capture the market’s best days? By focusing on time in the market.
Don’t be fooled—timing the market won’t get rid of anxiety
Investing is a battle of emotions. The fear of loss is stronger, making the temptation to time the market more attractive. But market timing is more emotional than just staying invested. If you were correct and timed the market well, this produces excessive confidence. You overestimate your ability to make similar moves in the future. If you weren’t correct and you are watching stocks go up while you are waiting on the sidelines, this causes FOMO, the fear of missing out.
No matter what happens, it still causes anxiety, because you are trying to control things that are outside of your control.
No one knows whether the next 10% move in stocks will be up or down. We do know which way the next 100% move will be. Don’t miss out on it.