The DOW crossed 35,000 for the 1st time last week. My father asked if it was a good time to cash out of the market. An avid market follower, my father had hibernated from stocks since the 2008 financial crisis, putting his money into low paying, but “safe” CD’s. The stock market rally that began in March 2009 and reached historic highs finally enticed him to consider investing in equities again. Alas, my father’s behavior is typical of many retail investors – often the one to sell low and buy high. Many investors missed out on the post- financial crisis rebound.
While the impulse to sell now is based on the emotion that the bull market might be strong, we request you stay invested. Because the short-term market is unknowable, market timing is always risky and largely futile proposition. Time, not timing, is the best way to capitalize on stock market gains. By trying to predict the best time to buy and sell, you may miss the market’s biggest gains. The U.S. stock market has been resilient throughout its history. Stocks routinely recovered from short-term crisis events to move higher over longer periods. The chart below tracks events in the last decade and the growth of $10,000 invested in the S&P 500.
Is there a cost to Market Timing?
Even for those who manage to time the market correct 50% of the time, a closer analysis shows that the returns are likely to be offset by the increased costs associated with market timing. These costs which can be significant include:
Trading costs: such as redemption fees, brokerage fees, sales charges from portfolio turnover.
Taxes: Capital gains taxes from selling investments may erode potential gains and increase potential tax liabilities. The recent increase in long term capital gains and dividends taxes makes this worse.
Opportunity costs: Market timers may miss the worst periods, but many studies show that they are more likely to miss the best periods as well.
Humans experience emotion – it is a biological fact. And when it comes to money, science shows that our emotions can be quite powerful. Unfortunately, those emotions can drive short-term thinking and erratic investing choices.
These emotions lead to buying and selling at the wrong times. Which could be an expensive affair as the chart below shows:
These strong emotions can cloud an investor’s judgment, resulting in costly mistakes, such as buying at the market’s peak or selling just before the market rebounds. So why do so many investors do the opposite, sell winners too early and ride losers too long? The answer is largely in our desire for the emotional benefits of pride and avoidance of the emotional costs of regret. A gap in returns between what the index does, and what an investor does is called Behavior Gap, a phrase coined by Carl Richards, who quipped, “Investments don’t make mistakes, investors do!”
Hindsight is accompanied by the emotional costs of regret. We kick ourselves for being so stupid and contemplate how much happier we would have been if only we had kept our $100 in our savings account or invested it in another stock that zoomed as our stock plummeted. Regret is painful enough when we face our paper losses, but the pain of regret is searing when we realize our losses because this is when we give up hope of getting even by recovering our losses.
But the lessons of regret are overly harsh and the lessons of pride too encouraging. Stocks go up and down for many reasons and no reason at all. We need not kick ourselves with regret every time stock prices go down, and we should not stroke ourselves with pride every time they go up. We can overcome our errors and realize our losses.
Missing the Market’s best days has been costly. The chart below shows the growth of $10,000 invested in the S&P 500 since 1991- 2020, in different scenarios.
The Price of Panic- Almost $1million loss:
Let us remember, despite repeated, sometimes verbatim, predictions of dire global catastrophe or outrageous economic boom, the markets have been resilient to either hyped extreme.
In the chart below, we see how fear and panic cost an investor heavily!
Let’s assume, each investor started with $0 invested on 12/31/79 into the S&P 500 Index. However, the opportunistic investor invested $2000 each time the market dropped 8% or more in a month and the apprehensive investor shifted assets to safer investments in the face of volatility. Ultimately, the opportunistic investor had a significantly higher investment value in the end. (This is for illustrative purposes only and assumes no taxes or transaction costs.) Source: MITAgeLab, Hartford Funds.
The difference in returns is almost 1million dollars! A huge price to pay!
Why did it happen? The apprehensive investor that panicked during times of volatility, shown in orange in this chart, enjoyed a less volatile experience but ended up with far fewer assets than the opportunistic investor. When the market dropped 8% in a month, the apprehensive investor moved 20% of their assets into cash investments. After several of these moves, the investor was completely invested in cash and missed the growth experienced by the opportunistic investor.
How you choose to respond to this turmoil can dramatically affect your long- term performance. When the market is declining and the news is depressing, the urge to panic and “play it safe” can be intense. We saw above that the price of the mistake is a big one! You have lived and thrived through each one of them, and this too shall pass!
Research conducted by Dr Daniel Kahneman, one of the founding fathers of behavioral economics and the only psychologist to ever win the Nobel Prize for Economics, suggests that:
- When faced with uncertainty, investors tend to make decisions based on their emotions and subjective experiences, not on logic or objective reality.
- As a result, investors can easily make the wrong decision for their situation.
Summary: So, is it too late to jump in or should we cash out?
With apologies to my father, we think that is the wrong question. Rather than fretting over whether or when to jump in or out of the markets we recommend implementing – and sticking with – a dynamic and diversified investment strategy with taxes and expenses an equally important factor to the decision.
That way, you won’t have to guess what today’s market will do next. When you avoid focusing on short-term market noise instead make decisions based on facts, fundamentals and long-term trends, you (and my father) can jump in and stay in and feel more confident, knowing that markets historically have rewarded fundamentals over the long haul.
While the present is fearful, and the world seems to be volatile, we know it does not end. The investment world can be complex, with multiple asset classes and a wide variety of investment vehicles and choices. Remember, your portfolio follows a diversified approach. It is designed to weather short term storms. These bear markets do not last forever. Markets recover! Your success will come from your ability to weather the storm. Viewing volatility as an opportunity or as a threat can lead to far different results- a million dollars different!
Original source for article content collection and creation – Aradhana Kejriwal, CFA – Practical Investment Consulting.
Sources for charts and content: Hartford Funds, MIT Agelab, PIC, JP Morgan, Dr Daniel Kahneman, Carl Richards
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