Why Timing the Market is a Bad Idea

Here are the headlines that I saw when I googled “stock market” today:

 

“Is a global recession led by a US Stock Market crash in the offing?”

“Dow slides as US stock market suffers worst week in two years”

“Chart analysts see bigger market pullback if interest rates continue to shoot higher”

 

These headlines are going to affect everyone differently.  Let me share with you how it affects me.  Normally, I would never read it.  But today,

I laugh at it.

It’s useless information.

Let me give you a little background on me.

I worked for Fidelity Investments as a stock broker while I was in college before I joined the military.  I’m an avid finance nerd and real estate investor.

I’ve studied the markets long enough to know that index funds are the smartest way to invest your money.  Trying to beat the market is pointless.

I also know that a lot of what you see in the financial media space is useless information.  They try to predict where the market is going.  When they get it wrong, they try to explain logically why they got it wrong, which ends up being the perfect definition of hindsight bias.

Hindsight bias, also known as the knew-it-all-along effect or creeping determinism, is the inclination, after an event has occurred, to see the event as having been predictable, despite there having been little or no objective basis for predicting it.

Financial magazines, newsletters, cable programs, videos, it’s all meant to capitalize on either fear or greed.  A few weeks ago, it was greed.  The markets were kicking ass.

Today it’s fear.  The end is near.  A crash is imminent.  What do we do now?  Keep watching the media outlets and they will tell us!

Now the real point of me writing this post.

No, You don’t need to sell when the markets starts diving again.

 

Another scary headline from today:

 

“Stock market loses nearly $1 trillion on the week”

But that’s not actually true.

The stock market didn’t lose anything, and neither did you.

You see, the stock market theoretically lost value.  It wouldn’t actually lose $1 trillion unless everyone in the market collectively sold their assets at the end of the week and locked in those losses.  I hope you didn’t do that.

I didn’t.

If you didn’t sell at the end of last week, you didn’t lose any money either.  I don’t care what the daily balance on your IPhone says.  That’s a theoretical number.  That’s the money you would get if you were to sell everything now.

If some of you need access to your money that’s invested in the market right now, than I’m not sure what to tell you.  I hope you are diversified, and you’ll have to decide whether to sell or not.

But most of you, including me, are investing for the distant future.  The drop in stock prices yesterday, last week, and even last month is totally meaningless.  So is the recent gain in prices.

The market fluctuates in the short term for many reasons that the media tries to explain.  Whether they are right or not is pointless.  It fluctuates in an unpredictable way over short periods of time.  I would define that as days, weeks, and even months.

The important thing to remember is that over long periods of time, the stock market has consistently delivered roughly 7-8% on average.  This is all you need to worry about.  Fretting over the short-term movements and especially the corrections is a waste of time.

That 7-8% average growth includes the corrections.

If you try to “time the market” and get out on the drops and back in on the rises, the statistical chances of success is super-low.  That 7-8% historical return will be reduced by quite a lot when you start playing games like that.  Additionally, you are liable to have your money on the sidelines when a large jump happens.

When you time the market, you have to be right twice.  You have to sell early enough in the drop.  Then, you have to guess how low it will go and try to buy back in again when you think it’s at the bottom.

Timing the market doesn’t usually work that well.  You’ll find that when you sell, the market shoots back up.  You will regret your decision and buy back in, then it will dive 40%.  This sucks!

Don’t try.  The market is a tricky beast.  The chances of being right twice are very, very low.  Trust in the system of riding the corrections out and getting your historic 7-8%.

Don’t mess with the system!

I know these corrections or even bear markets can be emotional hell, watching the headlines is torture, and watching your balance dwindle everyday scares you to death.

Keep in mind, you didn’t sell.  Those shares are still there.  They are theoretically worth less today, but will be worth much more again in the future.

Know that the stock market always comes back.  History has repeated itself several times.  It will happen again and again.  The media will freak out everytime, and a lot of people will sell at the bottom, and buy back in again near the top, and kick themselves!

Understanding something about the psychology of money is important.

Experiencing a loss of money is twice as painful emotionally as experiencing a gain.

Why is this important?

I told you before that the movements of the market over short terms are meaningless.  It’s just noise.  Hours, days, weeks, and even months are unimportant time frames.

Read What Beer Teaches us About Money

The more frequently you look at your account balances, the more unnecessary anguish you put yourself through.

This is because even if a stock or an index rises over the course of a year, if will go up and down frequently over short terms.  The less you look at it, the better.  I can go months without checking my investment accounts.  I really don’t care.  I don’t need them until I’m old!

Neither do you.

When times get tough, remember the following:

  • The market always comes back, and continues its relentless march upward
  • The account balance you see doesn’t mean anything unless you sell, you still have the shares
  • Don’t stare at your account balances, it’ll mess with your head
  • The media is a joke

And just to mix things up a bit, since I’m a real estate investor…

  • Having passive income from real estate is a great diversification strategy

Check out my Complete Guide to Real Estate Investing.

 

Disagree with me?

 

Let’s duke it out in the comments.

Rich on Money

 

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4 Comments

  1. Shawn

    Very well said rich! Hope to see u in Greece in October?

  2. Joe

    Rich – may I ask what your thoughts on the current media and industry push back to active management? It’s fierce now. A couple things I keep hearing:
    – foreign or emerging market funds need to be actively managed. Who will know the market better a computer or manager (specifically for emerging or international)?
    – sense the indexing market has become so large, there is a fear of bubble, or big herd (moo cow) in the market. There is a thought from big minds (yes, industry minds) that active management will play a bigger role as gains and opportunities outside the index will appear. (When?)

    Bottom line does a 70bp fear, justify the expense? That’s the price difference in my 401k between index and managed fund.

    I am an indexer, but I like to have an open mind and not get blindsided as it’s worked (so far).

    Thanks – loved your CAP rate article. One of the best I’ve seen!!!

    • Joe, Thanks for the comment. I’ll give my opinion on this. I definitely don’t care what current media or industry are pushing for. If they are pushing me to sign up for active management, and that means I’m gonna pay extra money to line someone’s pockets to invest my money and supposedly beat the market, forget it. I understand the math. A large majority of managed funds will fail to beat the market (indexes) over the long term, but they will get paid for trying. It won’t be by me. I don’t think there can be a bubble in index funds. The kind of investing that is done by investors in index funds is totally dwarfed by what investment firms do on a large scale. What individuals do is just a blip on the screen. You can’t go wrong with indexing. I’m gonna write a post on why everyone should fire their money managers.

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