The dumb investing mistake that smart people make over and over again
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This approach is called ‘timing the market,’ and it’s one of the fundamental mistakes even experienced investors make that causes them to miss opportunities – or worse, lose money.
On the surface, this train of thought seems pretty reasonable based on some basic facts about the current market:
A rational decision-making process would take true facts about the market into consideration. The problem, however, is when you throw in one final statement to that list: “It’s going to crash soon.”
This is not a fact.
The belief or assertion that the market will crash in the very near future is just that: a belief. To be more accurate, it’s speculation.
Absolutely no one can predict what the stock market will do next. It’s worth repeating: anyone who thinks they can do it is speculating, guessing, or forecasting.
Again, it’s pretty reasonable to think “what goes up must come down” when it comes to the stock market. You’re right: It will crash – eventually.
It could happen tomorrow, or it could happen in two years. Maybe it won’t happen for another five. The point is that we don’t know exactly when, and he fear that “eventually” means “tomorrow” keeps many from taking action. The aversion to loss prevents them from simply taking the cash they have sitting on the sidelines and investing it.
But what if it does take two more years before we see a market correction? If that’s the case, these people will just be sitting on cash, and potentially incurring massive opportunity costs because of two missed years of potential market growth.
This isn’t just a hypothetical scenario. Just take a look at this Marketwatch article from March 2015. It includes lines like this: “the Crash of 2016, one that promises in the end to become bigger and badder and far more dangerous than 2008, 1999 and 1929 combined.”
This writer was so confident in a market crash that he began the article by saying, “It’s time to start the countdown to the crash of 2016. No, this is not a prediction of a minor correction. Plan on a 50% crash.”
I don’t know if you can remember back to 2016, but the S&P 500 returned 11.9% that year. Not exactly what I’d call a crash… and much less a loss of 50% of the stock market’s value.
And yet today, we still see articles showing how 58% of investors think the bull market is on its last legs and 2018 is the peak.
Those investors could be right – or they might end up being as wrong as the doom-and-gloom forecasters of 2016.
This is all well and good, you might say, but what if this is actually the time the speculators guessed correctly?
That’s a valid fear. After all, chance says they have to be right eventually– the market will go down at some point.
But even if that happened, even if you invest your cash today and the market tanks tomorrow, you are likely better off making that investment than continuing to sit on the sidelines, and missing out on time in the market – if your goal is long term growth.
Don’t believe me? Look at the case study by Ben Carlson of A Wealth of Common Sense to see what actually happens in this very scenario:
Meet Bob, the “World’s Worst Market Timer.”
Bob does exactly what you think he would from that kind of title: he consistently invests at the absolute peak of the market, just before it suffers some of the worst crashes in its history.
Bob is pretty much your worst nightmare if you’re sitting on cash thinking “I’ll wait to invest because I don’t want the market to crash right after I contribute to my portfolio.”
From 1972 to 2007 he only invested in the market in the months before major market crashes:
Surely, Bob is broke, destitute, and living in a cardboard box on the side of the road thanks to his awful decisions about when to invest – right?
You might think so, but you’d be wrong. Remember: It’s not about market timing. It’s about time in the market
In this scenario, Bob invested $184,000 in cash from 1972 to 2007. And what did he end up with in 2013? $1.1 million.
While Bob invested at the worst possible times, he never sold any of his positions. He never pulled his money out of the market.
Could he have had even more money if he chose different days to invest? Sure. But the original scenario set out to answer the question, “what happens if you invest cash right before every major market crash throughout your working career?”
In this example, the answer is you’d still be a millionaire.
(Another look at Bob’s situation, by the way, showed what would have happened had he used dollar cost averaging instead of trying to time the market. Had Bob done this with his $184,000, he would have turned it into $4.4 million.)
So rather than worrying about market timing, focus on setting up a systematic way to invest money so you make strategic, rational decisions, and not falling victim to cognitive and emotional biases that cause you to make silly investment choices.
Worrying about investing right before a market peak is a valid concern – and it’s also distracting you from what really matters.
It’s far more important to find systems and processes to help you manage your own behaviour so you can invest with greater success.
Eric Roberge is a certified financial planner and the founder of Beyond Your Hammock.