When building wealth for the long term, your goal should be long-term investing ‒ time in the market versus timing the market. This view represents the difference between being a long-term owner and a short-term renter (of stocks). If you can only take one investing axiom to heart, this might be the one.
Moving in and out of the market ‒ as many may have experienced ‒ can be a reactive and emotionally nerve-racking approach. When opportunity seems to beckon, many market participants jump off the sidelines and move their cash into the market in hot pursuit. Similarly, when the market is volatile, falling or otherwise scary, many of the same market participants flee, selling their investments and moving their cash back to the sidelines.
There are many risks of moving in and out of the market instead of staying put . . . selling low what you previously bought high, compounding that mistake multiple times, identifying the right company to invest in and getting the timing wrong, missing the opportunity to reinvest your dividends and accelerate the compounding of your returns, reducing your returns with high trading costs, creating unnecessary taxable events . . . the list goes on.
By contrast, patiently remaining invested in the market over time ‒ through the inevitable ups and downs of stock price swings ‒ may be far more profitable than attempting to time the market. This may be hard for gut-guided investors to accept. But the preponderance of evidence supports the likely greater value of taking the long view.
Studies of historical S&P 500 returns since 1928 have shown that the longer you’re in the market, the less likely you are to lose money. After one year, the probability of loss decreases markedly ‒ and the probability continues to fall over the subsequent several years of staying invested.
Another reason to remain invested for the long haul: stock market returns are lumpy ‒ they come from a mix of shorter periods of both rising and falling prices ‒ and it’s impossible to predict precisely when those periods will occur. Take a look at these successive five-year compound annual rates of return for the SPDR® S&P 500® ETF with dividends reinvested:
May 31, 1995 ‒ May 31, 2000 23.5%
May 31, 2000 ‒ May 31, 2005 -2.0%
May 31, 2005 ‒ May 31, 2010 0.3%
May 31, 2010 ‒ May 31, 2015 16.5%
Contrast the results above with the compound annual rate of return for the entire 20-year below for the same SPDR® S&P 500® ETF with dividends reinvested:
May 31, 1995 ‒ May 31, 2015 9.0%
Some might argue that it would have been better to invest only during the 1995-2000 and the 2010-2015 periods and avoid the market during the 2000-2010 period altogether. This makes sense only in a world in which you can see the future.
Besides, the market often bounces back quickly even after gut-wrenching price drops. In the days after the September 11 terrorist attacks, the Dow Jones Industrial Average plunged 11.6%. But over the following month it rose 13.6%. And three months after the plunge, it was up 18.5%.
A similar story has played out after a number of events, including the assassination of JFK, the Iranian hostage crisis, and even the market crash of 1929. The market plunged 43.7% during that month-long decline ‒ but over the following six months, it rose 46%. The bottom line: market drops are often followed by significant rises. Jump out at the wrong time, and you miss the rebound.
The market will continue to rise and fall, as it always has. The principal balance in your investment account will continue to “bounce” up and down. None of this should deter you from staying invested for the long term in accordance with a well-designed retirement and investment plan, and accelerating the compounding of your returns with dividend reinvestment.
If you need help developing an investment strategy to help you navigate the market’s ups and downs and help you more effectively build your long-term wealth and reach your goals, we may be able to help. That’s just part of what we do. Contact us.
Source: Intelligent Capitalworks, Bloomberg