Financial Planning, Millennials

How Impactful Is Market Timing?

“I am not going to invest now, are you crazy? Have you seen the market! It’s so high right now. There’s definitely going to be a correction soon.” 

How many of you have heard statements like this recently? 

I am guessing all of you answered yes to that question. We have all heard statements like this recently from coworkers, friends, family, etc. 

So… are they right? 

Honestly, I don’t know, they might be. They might not be. None of us are fortune tellers, we have no idea what the future holds. 

But is “are they right” even the right question to ask? Does it really matter that much if they are right or wrong?

I stumbled across an old blog post from Ben Carlson this past week that helps answer this question “Is market timing that impactful?” (check out the full post here)

In this post, Ben examines what would happen if you only invested at the market peak right before a crash. He uses a character, Bob. Bob wants to start investing $2,000 a year in the 70’s and then up that number every decade by another $2,000. So in the 80’s he would invest $4,000 a year and so on. As I said before, Bob is the world’s worst market timer, he invests his full lump sum every time at the worst possible time. In 1973, he invested his $2,000 and the day after the market nearly dropped 50%. This massive drop scares him into not investing again until 1987 — but it’s important to note he never sold those investments (in the S&P 500) and he saved the contributions he was going to invest in cash. By 1987, he now had $46,000 on the sidelines in cash to invest and again he has terrible timing and the market dropped 30% the next day. This spooks him again so he chooses to not invest again until 1999 where he had $68,000 to get into the market. This time he invested it just before a 50% downturn that went until 2002. This story goes on where he continues to not invest for a period of time, gets into the market right before a crash, then continues to hold onto his investments. 

How does it end up for Bob? Bob still ends up being a millionaire. He put in $184,000 over this investing period and retired with a portfolio balance of $1,100,000. Crazy, for someone who had the worst market timing. 

How did he end up faring so well even though he always invested at the worst times? 3 reasons and these are the key takeaways for you:

  1. He Stayed Invested – Bob didn’t panic and sell his investments when they went down. He trusted that the market would end up working out in the long run so he never sold when times were tough. 
  2. He Continued To Invest – Bob continued to save every year and then invest. He may have paused adding new investments in certain years, but he still saved that money and ended up investing. Continuing to invest for long periods of time will lead to great results. 
  3. He Had a Low Cost Diversified Portfolio – Bob had a portfolio that had hundreds of stocks and where the fees were low. 

However, for those of you that still may not be convinced I am going to cite another study from Charles Schwab that tries to prove a similar point. This study looks at 5 investors’ hypothetical performance over a 20 year period from 2000-2020 where each participant received $2,000 at the start of each year to invest. Here’s how it went:

Investor 1 – He had perfect market timing, he invests at S&P’s lowest point every year 

Investor 2 – Invest $2,000 right when she gets the money every year

Investor 3 – He breaks the $2,000 up equally over each month 

Investor 4 – She has the worst market timing, invests at S&P’s highest point every year 

Investor 5 – She keeps money in cash and waits for best time to buy, thinking there is always a lower price 

How did the results turn out this time?

Investor 1, the perfect market timer, ended up with the most money, $151,391 or a rate of return of right around 11.5%. However, he didn’t beat many of the other investors by much. Investor 2, who invested the money right away, took second with $15,920 less than investor 1, or a rate of return of 10.6%. Then in 3rd was Investor 3 who dollar cost averaged into their investments monthly. This was only $615 less than 2nd place or a rate of return of just under 10.6%. Not a huge difference between the 3 if you think about it. Perfect market timing didn’t even make a full percent difference! I am guessing most people would assume a larger impact than that.

The moral of the story is that looking for the best time to get invested does not make as big of a difference as you would think. No one is going to be able to do it perfectly, so you might as well just invest. At the end of the day, it won’t feel good if you invest right before the market drops, but… it’s a long term game you are playing — don’t panic, stick with your plan, and trust the future.

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