The stock market is off to a rough start in 2016. Actually, this could be big understatement; the S&P 500 index (^GSPC 0.32%) fell by nearly 6% in the first week of the year, which is its worst five-day start to a year ever. The economy in China is going through a lot of instability lately, and it's hard to tell how this could affect global markets in the coming months.
In this context, many investors are running away from stocks, selling positions before prices continue deteriorating and accumulating cash in their portfolios to reduce volatility during turbulent times. After all, this is the smart thing to do during a market correction, right?
Wrong -- dead wrong.
Time in the market beats timing the market
The historical evidence is quite clear: Most investors consistently fail in their attempts to time the market. Even the most famous and renowned market gurus have a lousy track record of market forecasting over the long term. Unfortunately, there is not enough accountability in this area, so the financial media keeps putting a lot of attention on these kinds of forecasts and predictions from financial pundits.
The point is that trying to time the market can be a remarkably expensive mistake. When trying to avoid declines you usually end up missing the most profitable days in the market, and this can be tremendously hazardous to your wealth. According to data from Wealth Management Systems and Standard & Poor's, missing only a few important positive days in the market can have a devastating impact on returns.
Some key statistics to consider:
- Over the 20-year period between Jan. 1, 1995 and Dec. 31, 2014, the S&P index gained 9.79% annually, meaning that a $10,000 investment would have turned into $64,752 by the end of the period.
- Missing the best 10 days over those 20 years would have reduced returns to 6.05%, and your capital would be nearly cut by half, with an ending value of $32,386.
- Missing the best 30 days would mean a minuscule return of 1.46% annually, and your money would be worth only $13,351 by the end of the period.
These calculations don't even include important variables such as transaction costs and taxes, which can have a big impact on your returns when trying to time the market. Considering the evidence, chances are that trying to time the market will turn out to be a massive mistake.
The smart way to approach market volatility
Corrections and bear markets are part of the game. You need to be willing to tolerate volatility if you want to capitalize on the amazing opportunities for wealth creation that the stock market provides. As opposed to trying to avoid bear markets, investors with a long-term horizon should better capitalize on the opportunity to buy solid investments at conveniently low prices.
You don't even need to assume a lot of risk to capitalize on market dips. An ETF such as Vanguard S&P 500 ETF (VOO 0.34%) provides an efficient vehicle to replicate the S&P 500 index for a compellingly low cost of only 0.05% annually. You can buy the Vanguard S&P 500 ETF with the same simplicity as buying an individual stock in your brokerage account, and you get the benefits of diversification for a remarkably low annual cost.
Investors in Vanguard S&P 500 ETF are getting exposure to 500 of the biggest and most successful businesses of our time, and chances are that these companies as a group will continue producing growing earnings and cash flows for investors over the coming decades, no matter how tough the economic environment in the short term. Stock prices can fluctuate widely on a day to day basis, but the long-term fundamentals are on your side when you rely on an ETF such as Vanguard S&P 500 ETF to invest in a diversified basket of solid businesses.
For those willing to assume more risk in exchange for bigger potential gains, a company such as Apple (AAPL 1.67%) looks like an attractive opportunity right now. Wall Street analysts are concerned about slowing iPhone demand, besides, China is a key growth market for Apple, so economic uncertainty in China is putting additional pressure on the company.
These are important risk factors to keep in mind when analyzing a position in Apple, but it's also worth noting that Apple stock looks remarkably cheap at current levels, so investors' concerns are already incorporated into valuations to a good degree. Apple stock trades at a price-to-earnings ratio around 10.5, a huge discount versus the average company in the S&P 500 index and its P/E ratio in the neighborhood of 19.
Apple is one of the most powerful and profitable corporations around, and the business produces tons of cash flow that management is putting to work for the benefit of shareholders via dividends and buybacks. Even if growth slows down in the coming quarters, investors seem to be overreacting to this possibility, and Apple stock looks well positioned to deliver strong returns in the years ahead.
Depending on your own investment strategy and risk tolerance, you can find many attractive possibilities in times of market turmoil. The main point is that market volatility is no reason for concern; on the contrary, it can be a source of opportunity for smart investors with a long-term mind-set.