Nothing gets the financial press in tizzy quite like a run of “up days” for the stock market. And, nothing gets the mainstream media interested in the financial media’s excitement like a new RECORD!
Dow Jones Record High
The Dow Jones Industrial Average has notched some record high closes lately. The S&P 500 Index isn’t far behind, within striking distance of its record high as well. So, what do these new stock market records mean for smart investors?
First, the recent stock market records are a lesson to be learned for long-term investors such as retirement investors. When the market looked terrifying in 2008 many people sold off stocks in their 401k plans and other retirement savings, often after much of the damage had already been done. That was a foolish strategy then, but now, five years later, those investors are officially the fools. You were better off to have just stayed put.
Harsh? Maybe, but if you are investing for retirement or other long-term horizons, this is a critical lesson to learn.
In a recent discussion someone said to me that he was sure he did better by getting out when things were bad and getting back in now than he would have been to ride it out. This is a fundamental misunderstanding that cripples the potential investment returns for a lot of investors.
First off, believe it or not, this is marketing timing. However this person (and many others) doesn’t see it that way. He wasn’t trying to “time” when the market would go down, or go up. He was just trying to avoid some damage by getting out of the market when things were bad. Even it if it doesn’t sound like it, that is exactly what marketing timing is. Getting out when things are “bad” is trying to time the bad times, and then getting back in when things are “good” is trying to time the good times. It is just on a slightly longer scale than those who try and pick the right month, right week, or right day to invest or sell.
Let’s use this recent Great Recession market beating as a learning tool to show that over the long-term, staying invested is always better than trying to time the market.
For simplicity, let’s assume you have some sort of portfolio that exactly mimics the Dow index. If you were the best market timer ever, then you sold your entire portfolio on the exact day that the market peaked on October 9, 2007. Now, a little more than five years later, if you bought back in exactly when the market retook that peak, you made a zero percent return. Congratulations.
However, consider this. If you stayed invested that entire time, you would also have a zero percent return, the exact same return as the perfect market timer.
In fact, there is only one way to lose this contest. If you sold at any time after the peak, then you have a negative return right now, because you had already taken losses before you sold, and with that money out of the market, even if you get back in at the peak, you are still down. Even worse, if you still aren’t back into the market, you are losing even more ground as those who are invested are starting to earn positive gains, while your money sits on the sidelines.
In other words, any market timing other than PERFECT market timing lost money while staying invested and riding it out did not lose any money.
Is Now the Time to Invest?
Here is the really hard part. If you did pull your money out of the market, you have to decide when to time getting back in. (See is really is just market timing on a longer scale.)
Is now the right time to put your money back into the stock market?
Unfortunately, nobody knows, just like no one knew when the market peak was happening. The markets could turn lower sooner or later. If so, now not only do you have your previous losses (and no gains over the last five years to erase them) but you could add even more losses if the market goes back down. On the other hand, if the market goes up substantially from here, every day you miss is a day you lose out on positive returns and keep your losses locked in. But, here is the catch, that will ALWAYS be true. No matter when you invest, the market could go down or up.
So, what is the right answer about when to invest?
To answer that question, let’s look at a fourth scenario in our above example.
Let’s say that you stayed invested AND you kept investing. If it was your 401k, you kept plugging in your contribution over the last five years.
You don’t have a zero percent return (or negative return) like the others, you have a POSITIVE return.
How did that happen if the market was so bad?
Everyone knows that to make money in the stock market you have to buy low and sell high. What people have a very hard time understanding is that buying low, often means buying when the market is down. Since the peak of the market was in 2007 and the market is now above that peak, every single penny you invested in between those two days has a positive return. The money you invested when times were at their “worst” is the money that has the highest return.
For long-term investors, now is always the right time to invest. If the market rolls over and heads back down, the money you invest today will be the money with a positive return the next time the stock market sets a record.