Many consider the stock market to be the greatest wealth-building tool that anyone has at their disposal. I tend to agree with this mentality. Putting away a seemingly small amount of capital, on a consistent basis and for a long enough time, can result in magnificent returns for the individual investor. But it's not exactly a perfectly straight line.
As of this writing, the S&P 500 and the Nasdaq Composite Index are 14% and 25% off their respective all-time highs. So naturally, investors are probably wondering if the market has hit bottom and if it's on its way up again for good. While this way of thinking likely permeates across the investment world, the better question to ask is: Am I in a position to continue being a buyer of stocks?
Here's why this matters more.
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Timing the market
The stock market is volatile. Anyone who is an investor knows this. That's why the best approach is to focus on owning wonderful businesses for the long term instead of worrying about the day-to-day movements of stock prices. The thinking is that it's impossible to predict what will happen with markets and the economy in the short term, but over time, prices go up and the economy grows. And the best companies should be able to overcome whatever challenges are thrown their way.
This rational way of thinking doesn't stop people from trying to time the market, getting in and out of stocks because they believe the market has bottomed out or hit a peak. But this is a losing proposition, something that a wild statistic from Bank of America clearly proves. According to the large financial services entity, if an investor missed the 10 best trading days in any decade since 1930, that person's returns would be drastically lower than if they had simply held through the ups and downs.
In the 2010s, for example, the S&P 500 gained 190%. Excluding the 10 best trading days, the return gets cut in half to 95%. On the other hand, if an investor missed out on the 10 worst trading days in the 2010s, the return would've been 351%.
It's tempting to believe one can easily time the market, avoiding the bad days and capturing the good days. But Bank of America also found that the best days often come right after the worst days. So, you might get lucky and miss a big price drop, but it's likely you'd also miss the immediate bounce-back. This is why asking the popular question of whether the market has hit bottom is the wrong way to think.
Personal finances matter
With this framework in mind, the right approach is to be fully invested in the market at all times. And it's critical to understand and accept that the ups and downs are just part of the journey to building lasting wealth. Constantly trying to maintain this mentality, and keeping your emotions in check, is paramount.
In order to remain fully invested, though, having your personal finances in a good position is crucial. Obviously, there is no one-size-fits-all approach here, but it generally means that you've paid off all high-interest debt and have an adequate emergency savings fund tucked away. This ensures that should market prices drop for whatever reason, you are not forced into selling your positions because of a cash crunch.
The other piece of this is to continually add to your portfolio on a recurring basis, something called dollar-cost averaging. Again, because it is virtually impossible to correctly call market bottoms and tops, it's best to just buy stocks on a set schedule, so your portfolio can take advantage of multiple-entry price points. This updated way of thinking about the stock market should benefit anyone's investing approach going forward.
