You’d be forgiven if you saw the recent all-time highs of the stock market and thought the gains we’ve seen in 2020 are not sustainable. In fact, amid mounting unemployment, continued economic intervention by the Federal Reserve, and a staggering death toll from a life-altering virus, the stock market seems to be disconnected from reality.
These factors alone might be enough to convince seasoned investors to sell out of their winning positions, put that money in big bags marked with dollar signs, and wait for the inevitable correction. Despite that very rational inclination, don’t try to time the market by selling now and buying later; instead, take both your hands and firmly sit on them.
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Market Timing is a Losing Battle
The market will crash again. It might not be today; it might not even happen for years, but it will happen. On average, over the last 70 years, the stock market has fallen by at least 10% once every 23 months. These market corrections are sometimes gut-wrenching, but they are inevitable. However, the longer your time horizon to buy and hold great companies, the more likely you are to see growth. This is because, despite factoring in frequent corrections, the S&P 500 (the generally accepted representative of the U.S. stock market) has averaged returns of roughly 10% per year over the last century.
This is why odds of trying to time the stock market are simply not in your favor — after you’ve sold out, the market tends to continue upward. Successful timing is made harder when you consider that even major stock market corrections such as the Great Recession appear only as blips on a stock chart. These blips seem rather inconsequential in what otherwise is an exponential curve from the lower left to the upper right over the long term. While these corrections may truly be inconsequential to the buy-and-hold investor over an extended time, corrections don’t exactly feel that way in the moment.
For example, let’s look at the market correction in mid-March. At first, investors may have seen a five percent drop in the stock market and rushed in to buy companies on sale. While this would have served you well enough as the S&P 500 now hovers around record highs, you would have missed out on the rest of that 30% descent. Similarly, once market prices hit bottom in March, many investors sat on the sidelines waiting to get a better deal. Investors who waited too long to get invested missed either some, or all, of the rally we’ve witnessed over the past few months.
If this feels particularly relevant it’s because the market’s 4.3% drop in two days has left investors questioning if this is the next big correction. Instead of making investing difficult on yourself, let’s look at an alternative strategy that removes the guesswork of trying to time the market.
Enter Dollar-Cost Averaging
Instead of trying to invest in the companies you love based on short-term market fluctuations, one popular strategy is dollar-cost averaging. Despite the mathematical sounding name, dollar-cost averaging is very straightforward: instead of buying your full position in a company all at once, you invest at regular intervals (such as once a paycheck, monthly, or quarterly).
Rather than investing based on emotion, intuition, or pure luck, someone who dollar-cost averages invests at pre-planned times. This can be particularly helpful in times like these, with periods of widespread market volatility. If you had dollar-cost averaged your investment approach back in March, you might not have invested exactly at the bottom, but you would have invested throughout the correction. Even if you had bought an index that tracked the S&P 500 at the worst time to buy in March (well before the market hit bottom), you would still be sitting on returns of more than 13%! Dollar-cost averaging can allow the investors to sleep at night without agonizing over the day-to-day fluctuations of the market.
Just Don’t Sell
If dollar-cost averaging into the market is not for you, at the very least, don’t sell. Make sure you aren’t investing any money that you will need in cash over the next three to five years, and be ready to invest in both good times and bad ones. Semi-frequent drops in the market make great buying opportunities; however they are just that — opportunities to buy more of the companies you love. If you are convinced there is going to be a stock market crash, a winning move could be to continue to build your portfolio through dollar-cost averaging while building a cash position. This way, you aren’t missing out on holding the companies you believe in if a market correction doesn’t come. And if it does, be ready to deploy that capital and buy great companies on sale.