As the stock market continues to reach new highs, it’s tempting to think about the possibility of buying and selling at just the right moment.
Here’s a dirty little secret that most of the investment industry doesn’t want you to know: Time is more important than timing in investment success.
A good example of this comes from an analysis described by the legendary Peter Lynch on the effects of market timing on performance over a 30-year period from 1965 to 1995.
If you had invested $1,000 on the lowest day in the market of each and every year, you would have earned an average annual return of 11.7%. On the flip side, if you had invested at the market high of each year, your return would have been 10.6%. Finally, if you had simply invested $1,000 at the start of every year, you would have earned 11.0% per year.
Let’s recap the findings:
- Perfect market timing return = 11.7%
- Worst market timing return = 10.6%
- No market timing return = 11.0%
There are a few takeaways from this simple study of market timing. First, the reward for perfect market timing is very small considering it’s impossible to consistently time market movements over long periods of time. Given that it is extremely unlikely that you will be able to time the market correctly, you may miss out on opportunities by moving in and out of stocks.
Second, the average returns were achieved because the investor – whether he/she had good or bad market timing – never sold in down markets and allowed returns to compound over time. These returns weren’t achieved because the investor side-stepped the many downturns that occurred during the period. The average returns include both the really good times and the really bad times.
In one of my all-time favorite blog posts, Ben Carlson performs a similar analysis in which an investor only invests at the market peaks (Dec. 1972, Aug. 1987, Dec. 1999, Oct. 2007), but never sells.
In both studies, the investor never sells out of stocks and allows returns to compound over multiple decades. Even though Wall Street would like you to believe that investment success requires a complex strategy, it is time and the power of compounding that are the biggest drivers of building wealth through investments.
It’s easy to come up with reasons why the market might crash, but it is important to remember that stock investors are compensated for assuming the uncertainty of short to intermediate stock returns. In order to receive a rational premium for owning stocks over bonds and cash, stocks occasionally need to lose value.
Stay invested through all market environments and time will reward you for your patience.