The premise is promising enough on paper: Buy stocks at the exact bottom of major sell-offs, and get rich by riding the rebounds.
That idea, however, glosses over a critical detail: You'll never know where (or when) the exact bottom is. If you exit your investments ahead of time, you probably won't even get meaningfully close to jumping back into stocks at the exact right time.
Image source: Getty Images.
Don't sweat it, though. You don't need to be a laser-precise market timer. In fact, you're arguably better off if you don't even try to be.
If the professionals can't even do it...
For the record, there are plenty of pundits, technical analysts, and so-called gurus who will attempt to tell you otherwise. Many of them rely on some sort of chart-based or data-based algorithm with a back-tested track record. Several of them also still make their calls the old-fashioned way -- trusting their gut. Every now and then, a few of these folks are right too.
By and large though, these bottom-finding efforts are a bust.
Nowhere is this more alarmingly evident than in the regularly updated looks at the performances of mutual funds that Standard & Poor's makes available to U.S. investors.
Simply put, given enough time, most equity mutual funds (actively managed or passively managed) underperform the market's primary benchmark -- the S&P 500 (^GSPC 0.32%). It's usually not even close. Over the course of the past 15 years, 94% of mutual funds lagged the S&P 500's gains. For the past five years, over 86% of funds didn't keep up with the S&P 500. Last year, nearly half of U.S. mutual funds beat the broad market. Just bear in mind, stocks suffered a loss last year; many of these funds simply lost less value than the S&P 500 by virtue of holding lots of cash and/or less volatile stocks. These funds aren't particularly well-positioned for sweeping rebounds.
Now think about that for a minute. Not that every equity fund manager's top goal is beating the market. But most fund companies would love to tout a fund that can boast market-beating performance. The bulk of these professionals can't deliver that with any consistency despite having access to all sorts of tools and data, and despite having plenty of freedom to not just pick stocks with the highest apparent prospects, but to pick when and at what price they're bought.
Take the hint. If the professionals can't time the market well enough to beat it, most average amateurs won't be able to either. In fact, trying to do so might actually crimp their overall long-term returns -- quite seriously.
The price for being late (or early) is needlessly high
Consistently timing the market right is nearly impossible to do no matter how you try to do it. But, also keep in mind the price is very, very high when you get it wrong. See, some of the market's most bullish days materialize in the earliest phases of a bull market, when the world's still wondering if the gains are just a head fake.
Mutual fund company The Hartford fleshes out this point. It crunched the numbers and found that roughly three-quarters of the market's best days happened either during a bear market or during the first two months of a bull market. Research performed by Edward Jones paints the same basic picture in a different way. Its digging indicates that of the five most recent bull markets, the S&P 500 gained an average of 25% in just their first three months of existence. (While the jury is still out on the current bullish effort, the index delivered a 30% gain in the three months following March 23's low.)
Connect the dots. If you're late to the proverbial party, you miss some of its most rewarding parts.
But what if you've already made the mistake of trying to find the bottom only to end up missing out on gains, or maybe suffering a loss by getting back into the market too soon? That's OK. While you obviously don't want to make these mistakes over and over again, you can certainly offset them. Whereas the average bear market lasts on the order of 18 months, according to Edward Jones, bull markets on average last four and a half years.
Bull markets generally drive more gains than the losses resulting from bear markets too. Jones' math indicates the average bull market carries stocks a little more than 150% above the low corresponding with the bear market before it.
Just get in and stay in
The numbers and data largely speak for themselves. If you need the lesson spelled out for you though, it's this: Just buy and hold stocks with at least a five-year time frame in mind. That should be a more than adequate amount of time for a holding to push past any temporary weakness, negating the need to figure out where the market's or an individual stock's lows are materializing.
Yes, it's an antiquated, stodgy idea. It also offers you your highest odds of actually keeping up with or beating the overall market.
Perhaps some words of wisdom from Warren Buffett will make the advice easier to take. As the Oracle of Omaha so adeptly explains, "The stock market is a device to transfer money from the impatient to the patient."
History has proven him right time and time again.
