If only we had a crystal ball, we'd all be billionaires. Unfortunately, it doesn't work that way, which is why trying to time the market is generally a bad idea. As tempting as it might seem to try to score a big win, you're almost always better off sticking to your investment strategy instead of trying to guess when to buy and sell.
Let's look at a few reasons why trying to time the market is a bad idea and how you can be a more successful investor.
Multiple Studies Show Individual Investors Do a Poor Job of Market Timing
A number of studies show that individual investors who try to time the market lag the returns of the broader indexes, such as the Dow Jones or the S&P 500. In general, these investors buy high and sell low, which is the opposite of what they are trying to accomplish.
A study released by DALBAR shows that, in 2018, the average investor lost 9.42% while the S&P 500 lost 4.38%. The primary reason is due to emotional investing -- buying and selling when it "feels" right instead of with a predetermined investment plan.
But, you might say, "I'm not an average investor. I'm above average!"
That brings us to our next point.
Even Professional Investors Can't Consistently Beat the Market
Warren Buffet is one of the most famous investors of all time. He and his partner, Charlie Munger, have built Berkshire Hathaway into one of the largest and most respected companies in the United States. They have largely done so through the strategic buying of undervalued companies. But even he doesn't recommend that people try to time the market. He recommends that most investors simply purchase an S&P 500 index fund, which is a low-cost fund that tracks the 500 largest companies in the U.S. The equivalent fund in the Thrift Savings Plan is the C Fund.
He has also left instructions to have 90% of his money placed into an S&P 500 index fund to leave for his wife after he dies. The other 10% will be placed in government bonds.
Want further proof? Buffett made a famous 10-year bet with hedge fund managers. The stakes: $1 million to the charity of the winner's choice. The wager was to see which investment would perform better over a decade -- an S&P 500 fund or any of five hedge funds run by the firm Protégé Partners. Over the course of a decade, the S&P 500 gained 125.8%, while the hedge funds returned an average of about 36%.
To Effectively Time the Market, You Have to Guess Right Twice -- When You Buy and When You Sell
Timing the market once is difficult. Timing it twice is nearly impossible. To maximize your returns, you have to buy and sell at the right times. If you believe the market is going to drop, you have to time the market at or near its peak. Then, after selling, you have to determine when you think the market is going to rebound. Guessing wrong either time can potentially wipe out any gains you might have had. Even worse, it could bury you much deeper than you would have been had you not taken action.
External Factors Can Have Unforeseen Impacts on the Market
Black Monday, 9/11, the Great Recession and the COVID-19 pandemic -- all of these were unforeseen events that had dramatic impacts on the stock market. In some cases, the market quickly rebounded. In other cases, it took years for the market to recover. The recovery period directly after these events is typically marked by extreme levels of volatility, making it even more difficult to correctly time the market.
What to Do Instead of Market Timing
Instead of trying to predict the unpredictable, you will be better served to come up with a plan that you can stick with. You can do this by thinking about your risk tolerance, creating an Investment Policy Statement (IPS), and making your asset allocation match your risk tolerance and IPS.
An IPS is a simple document you can create that states your investment goals and objectives and how you will achieve them. You can reference it anytime you are thinking about buying or selling stocks because it "feels" right. Your IPS will help to guide you through troubling times.
Finally, stick to the basics: Invest in low-cost index funds that track the broader stock market and invest automatically through your paycheck or through allotments. Investing in your TSP or your 401k is a great way to automatically invest each month.
Setting up a simple investment plan, and sticking with it, will not only help you sleep better at night, but it will most likely give you better investment returns in the long run.
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