Want to become fantastically rich by investing in the stock market? All you have to do is buy low, and sell high, right?
That sounds simple enough, but there’s mounting evidence to suggest that this is a fool’s game. (Remember our post on a cat with a toy mouse beating professional money managers?)
But there’s a bigger hazard. The quest to “time the market” may lead you to keep your money on the sidelines. And academic research shows that there is a massive opportunity cost when timing the market prevents you from reaping the advantages of time in the market.
What a Difference a Few Days Make
Everyone knows that the stock market does not rise or fall steadily, and that there are brief jumps and crashes that happen along the way. But what surprised a group of academics was that a tiny portion of those brief swings accounts for practically all of a market’s gains or losses over decades!
This might be hard to believe, but 95% of the market gains between 1963 and 1993 stemmed from the best 1.2% of the trading days!
That means that if you had missed the 90 best-performing days of the stock market from 1963 to 2004, your average annual return would have dropped from about 11% to a little more than 3%.
A narrow window of opportunity
An annual return gap of 8% is a big difference, and it illustrates the market-timer’s dilemma: How on earth can anyone be skilled enough to predict the 90 best trading days over a period of 40+ years?
“Market timing, then, is perhaps even more difficult and risky than investors have been led to believe,” writes Wesley McCain, one of the authors on the study.
“Every time an investor defers funding an IRA or a 401(k) plan “until the market gets better,” that investor is trying to time the market. Yet waiting can mean missing the crucial days or months when the market surges — a narrow window of opportunity most investors probably cannot anticipate.”
Time in market vs. timing the market
Moral of the story? Time in market is WAY more important than timing the market. You don’t want to be sitting pretty on the sidelines when these big moves are happening.
Yes, you’ll suffer inevitable losses every now and again. But you’ll also benefit on those unpredictable up days when a beaten-up stock market suddenly rockets higher.
After all, you have to be in it to win it!
New to Betterment? As the most trusted online financial advisor, Betterment offers a fully diversified investment portfolio of 12 global asset classes, optimized to provide you the best possible returns for both retirement planning and wealth building. Betterment costs 0.15% of assets under management annually for a portfolio of $100,000 or more. Learn more here.
This article was last updated on February 14, 2014
Was this article helpful to you?
Our newsletter is full of tips to help you lead a smarter financial life.