Investing in the stock market is one of the best ways to build generational wealth. The S&P 500, an index of the 500 largest companies in the U.S., has increased at an annualized pace of 10.4% since 1973, including dividends. That means a $1,000 investment 50 years ago would be worth a whopping $150,000 today.
But despite this impressive long-term track record, stocks are undoubtedly volatile. And this up-and-down nature results in investors trying to correctly predict the tops and the bottoms. This is a tempting thing to do, but it should be completely avoided.
With that being said, here's why timing the market is overrated.
In it for the long haul
First off, I think it's important to mention that timing the market means that investors are frequently moving in and out of stocks in order to avoid falling prices and take advantage of rising prices. This sounds like a good idea in theory, right? After all, we all want to find ways to boost our returns.
Moreover, stocks are volatile in the short term, as they are driven by sometimes unpredictable and random factors that might have nothing to do with the underlying businesses, including the weather, geopolitical tensions, or elections. Volatility is hard to stomach, especially when dealing with a sizable chunk of one's hard-earned savings, so naturally, investors don't want to ride this roller coaster with their money.
That's why trying to time the market, attempting to predict a bottom or a top, is so intriguing. This is more so the case in uncertain economic times, like what the U.S. has grappled with for over a year now.
But trying to time the market is a waste of time, and there's data to back this up. According to Bank of America, investors who missed the 10 best daily returns for the S&P 500 during the 10-year period between 2010 and 2020 would have seen their portfolios rise 95%. Had they stayed invested the whole time, their portfolios would have gained 190%. And while avoiding the 10 worst days would have resulted in an impressive return of 351%, it's worth noting the best days often come right after the worst.
As a result, it's virtually impossible for an investor to consistently make the correct decision to capture the best days and stay away from the worst. Plus, the need to constantly make the right market calls significantly raises the chances that costly mistakes are made.
There are also the tax consequences to think about. Investors who are always moving in and out of positions will likely pay much higher short-term capital gains taxes that can meaningfully eat away at their returns.
Image source: Getty Images.
Morgan Housel, a wonderful personal finance writer and partner at Collab Fund, explains it best:
I've learned that when it comes to earning high investment returns, market volatility is like an entrance fee at an amusement park. But few investors want to pay the market's entrance fee. They'd rather sneak in the back door, hop the fence, and outsmart security -- all of which is stressful and likely to fail. At both the amusement park and in investing, they'd have a better experience if they just paid the damn entrance fee.
Stick to this strategy
Keeping the information in mind that I just discussed, the best and simplest course of action for most investors is to just remain fully invested through the good and the bad times. This also requires the need to accept the fact that the market's ups and downs are just a part of being a long-term investor.
There are certainly times throughout recent history, like the dot-com bust, subprime mortgage crisis, coronavirus pandemic, and last year when it was very scary to be investing in stocks. But the market continues marching higher, just not in a straight line. Investors who really understand this reality should do well.
