Is a new bull market just around the corner? It's impossible to predict with any certainty what's ahead for the stock market in the short term. But overall 2023 has been a so-so year for stocks, with the S&P 500 up around 8% year to date after tanking nearly 20% in 2022.
Still, it's inevitable that, at some point, we'll enter a new bull market -- generally defined as a 20% rise in stock prices. The U.S. stock market has always rebounded from its losses. But if you're making investment decisions based on when you think the stock market will charge into bull territory, you're making a giant mistake.
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The expensive bull market mistake savvy investors avoid
It's only in retrospect that you'll know what date a bull market or bear market (a drop of 20% or more from recent highs) began. But many investors make decisions based on whether they think we're on the cusp of one or the other.
Some try to avoid investing during a bear market because they can't stomach watching the value of their investments plummet. Others don't want to invest in a bull market because they worry about overpaying for investments. Both of these approaches are forms of market timing -- which is often a costly mistake.
There's a common adage in investing: "Time in the market beats timing the market." In other words, even when stocks are volatile, you're better off investing and keeping your money put than you would be if you tried to avoid the dips. On the flip side, even when we're clearly in a bull market and everything seems expensive, you're better off investing anyway.
Research by Charles Schwab shows why market timing is typically a losing game. In 2021, the investment giant compared the returns of the following five imaginary investors, each of whom had $2,000 a year to invest in the S&P 500 index over the 20-year period that ended in 2020:
- Peter Perfect: Invested $2,000 at the lowest closing point of the market each year for 20 consecutive years.
- Ashley Action: Invested $2,000 on the first trading day of the year for 20 consecutive years.
- Matthew Monthly: Divided up his $2,000 into 12 equal increments each year and invested at the beginning of the month for 20 years straight.
- Rosie Rotten: Invested $2,000 at the highest closing point of the market every year for each of the 20 years.
- Larry Linger: Never invested in the stock market and kept his $2,000 in cash equivalents because he was waiting for lower stock prices.
Of course, Peter Perfect got the best returns, ending the 20-year period with $151,391. Ashley Action and Matthew Monthly achieved similar results, with $135,471 and $134,856, respectively, at the end of the holding period. But even Rosie Rotten, who was unlucky enough to invest at the market's peak every year, earned strong returns, with $121,171 at the end of 20 years.
The only one who had truly rotten results? Larry Linger, who never put his money in the market because he was hoping for bargain stock prices. After 20 years, he was left with just $44,438 from cash equivalents.
Larry Linger's example shows the danger of attempting to ride out a bull market and invest when prices are low. The market may never reach the rock-bottom point you're waiting for. But if you apply Rosie Rotten's success to bull markets, you'll see that investing even when prices are relatively high can still pay off if you're patient.
Another thing to consider: Bull markets typically last far longer than bear markets. The average bull market lasts about 2.7 years, compared to about 9.7 months for bear markets. Even if you invest during a bull market, stocks could have many months or years of growth ahead before the next market correction occurs.
The investment strategy that beats market timing
Going back to the Schwab research: Both Ashley Action and Matthew Monthly practiced dollar-cost averaging. Essentially, that's when you invest in equal increments on a set schedule that you stick to whether the market is rising or falling.
For most investors, this strategy yields the best results since short-term market fluctuations are impossible to predict. If you invest in your employer's 401(k) through payroll deductions or you automatically transfer a fixed amount to your individual retirement account (IRA) each month, congratulations. You're already practicing dollar-cost averaging.
Consistency matters more than scoring stocks at a discount. Both bull markets and bear markets present opportunities. That's why savvy investors keep investing, regardless of which one they think is coming next.
