Investing in the stock market seems extremely complicated, but it can be incredibly simple. The key is to identify the highest-quality companies -- those that sell great products and services, have competitive advantages and solid growth prospects, and are trading for reasonable valuations. These criteria aren't difficult to fill. Moreover, it's important that investors maintain a long-term mindset, as a lot of time is needed to build truly life-changing wealth.
It's simple, but it's not easy. That's because often, the biggest barrier to achieving strong returns is the investor's own behavior and emotions. Here's one money-wasting mistake it's actually easy to avoid. You'll become a better investor by simply being aware of this.
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Don't try to time the market
Even though it's almost impossible to do successfully on a consistent basis, investors always think they can time the market, which is a huge mistake. To be clear, I fully understand why we feel the need to do this. It's all about jumping in and out of stocks with the goal of trying to avoid the worst days in the market.
In early 2020, when the coronavirus pandemic became a global health emergency, the natural inclination would've been to sell off your entire portfolio and move it all to cash. After all, there was so much uncertainty about the state of the economy and the direction the world was heading that it seemed like the safest move was to simply just own all cash.
But this would've been the wrong course of action. The S&P 500 and the Nasdaq Composite Index were up 16% and 44%, respectively, in 2020. You would've missed out on those wonderful double-digit gains had you transitioned the portfolio to cash.
To successfully time the market, one not only needs to know what real-world event is going to happen -- whether a pandemic, recession, war, or whatever -- but also the market's reaction to this event. That's extremely difficult to do. At any given point in time, the market is just a barometer of everyone's sentiment, and this can change in an instant. I don't think this is predictable with any level of consistent accuracy.
Time in the market always beats timing the market. Try to keep this in mind during your investing journey.
Aim to be fully invested
With this newfound knowledge, the best thing investors can do is remain fully invested (or as close to this as possible) at all times, adding new cash to the portfolio on a recurring basis. And it's always a good idea to be ready for the inevitable ups and downs. Although the CBOE (Chicago Board Options Exchange) Volatility Index has been declining substantially over the past year, investors should always be prepared for heightened volatility, especially given the uncertain current state of the economy.
If this does happen, the bid-ask spreads on stocks could widen, a clear sign that brokers are having trouble efficiently matching buyers and sellers. This is just something to keep in mind.
Trying to time the market is an urge that is getting more difficult to ignore. Thanks to the internet and smartphones, we can get bombarded with financial news updates seemingly 24/7 that might propel us to make portfolio decisions without thinking things through. And with zero-commission trading, investors have no friction when making buy and sell orders.
This type of constant activity can be fatal to one's portfolio, though. According to data provided by Bank of America, an investor who missed the 10 best days for the S&P 500 between 2010 and 2020 would have gained 95%, versus a 190% rise had they just stayed fully invested. Now, avoiding the 10 worst days would provide a serious boost to returns, but the data shows that the best days often come right after the worst days.
This means that in order to capture the benefits of investing in the stock market, it's critical for investors to keep their portfolios fully invested, and always maintain a long time horizon.
