With the stock market reaching all-time highs seemingly on a daily basis, you may be wondering whether you should (1) get out of the market and then reinvest at a downturn and / or (2) wait for a downturn to invest new money. In today’s blog post I answer these questions.
SINCE THE GREAT RECESSION
Since the 2008 financial crisis (i.e. The Great Recession) ended, the stock market has performed very well. For argument’s sake, I’ll reference the S&P 500 as the “stock market”.
The Great Recession officially ended on March 9, 2009 when the S&P 500 reached its low point. In total the stock market lost 57%. From the low point until today’s writing (August 31, 2021), it has returned approximately 18.50% / year.
Think about that for a second.
THE STOCK MARKET RETURNED 18.50% PER YEAR FOR OVER 12 YEARS!
To put that into perspective, a $100,000 investment at the beginning would have turned into $835,000 today.
Considering that the long term return of the stock market averages over 10% per year, it would be normal to consider getting out, collecting your profits, and waiting for another downturn to invest again.
Furthermore, these past 12 years have reinforced the idea that waiting for a downturn to invest could result in a nice-sized profit.
However, does waiting to invest actually produce more wealth?
To answer the question, I thought it would be beneficial to examine the concept of “always” waiting until a downturn to invest and then selling after the rebound. Rationally this makes sense because you’ve always been taught to “buy low and sell high”. But can it be done in theory?
I went backed and looked at the monthly data for the S&P 500 going all the way back to 1926, just before the Great Depression. What I discovered was that the rational is not always rational.
In theory it sounds great to buy at the dips and then sell after the rebounds; however, this strategy does not consistently outperform. Interestingly, staying invested the entire time is the generally the far better method.
Let’s look at some numbers and come up with some assumptions.
First, you have to determine when to buy. In this analysis I’ll assume that you want to get a really good deal so you buy when the market drops 35% (similar to what happened when COVID started). I didn’t choose a market level drop of 57% like we saw with the Great Recession as this only happens about half the time a 35% decline does. In other words, a 35% decline provides you with more opportunities to invest.
With a 35% decline, the market would have to then return 54% to get back to even. So, second, I’ll assume that you’ll sell after the rebound reaches that point.
As you can see, the goal is to avoid the downside but participate in the upside. Sounds good in theory, but soon you’ll realize that the rational is not always rational.
Note that some concessions have to made in choosing when to buy and sell as it will be very difficult to buy exactly at 35% and sell at 54%. In practice this means that I will invest if we are close to a 35% drop and sell if we are close to a 54% gain. It won’t be exactly on the mark.
The monthly data analyzed runs from January 1926 through July 2021.
What I discovered was that remaining invested built far more wealth than waiting for a 35% dip to invest.
|Invest After 35% dip / Sell After 54% Gain||Invest Now / Remain Invested|
|Beginning Value (1926)||$100,000||$100,000|
|Ending Value (2021)||$1.5 Million||$1.3 Billion (with a B)|
As you can see from the chart, investing right away or remaining invested caused wealth to grow to $1.3 billion, whereas trying to time the market only grew wealth to $1.5 million. I know what you’re thinking though – “I don’t have 95 years to invest!”
That’s a valid point, but consider that at virtually every step along the way from 1926 through July 2021, remaining invested produced a higher amount of wealth than moving in and out of the market.
After studying the data, there are two essential things to learn.
#1 THE MARKET DOESN’T ALWAYS REBOUND RIGHT AWAY AFTER A BIG DOWNTURN
The whole point of a person waiting to invest after a downturn is to avoid the downturn! Ironically though, you still may participate in the downturn if the market continues its downward trajectory. Granted you may have avoided some of the downturn, but this is usually not advantageous enough to overcome the subsequent gains you would have missed out on.
#2 WAITING FOR A DOWNTURN CAUSES YOU TO MISS OUT ON THE GAINS
The reason that investing now / remaining invested is generally the superior strategy is because the market is up 63% of the time and down only 37% of the time on a monthly basis. By waiting on the sidelines, you could miss out on years of gains. Case in point is that it took 32 years from April 1938 to June 1970 for a 30% or more decline.
If you happened to be waiting for a decline of this magnitude to invest then you would have been out of the market for 32 years! The market returned 12% per year during that period. A $100,000 investment would have grown to $3.8 million, but you would have missed out simply because you were waiting for a good deal.
First, don’t be invested just in the S&P 500. This wasn’t really the point of this article, but you take on great risk here. One investment category like this poses a lot of risk. It’s true it has returned very well over the last 12 years; however, it equally has had long periods where it hasn’t returned very well at all.
For example, from 2000-2009, the market lost approximately 1.00% per year. You may rationally think that 1.00% per year pales in comparison to the 18.50% per year you would have made over the last 12+ years; however, this is where “rational is not always rational”. If we combine the two periods (2000 – 2009 and 2010 – Aug 2021) the return is only 7.37% per year; far below the S&P 500 historical average of 10.43% per year. Just goes to show that the negative can greatly suppress the positive.
Second, remain invested (or invest dollars that are in savings). Don’t buy into the argument that the market is high and you need to preserve your gains or that you need to wait for a dip to invest. The market still could go higher especially if you are invested in more than just the S&P 500. Based on the data you could miss out on a long period of gains.
Finally, any time you try to determine when the best time is to invest, you are making a prediction. Predictions often times end up costing you a lot of money in the long run. Don’t fall prey to that. Financial science / evidence is a far better approach.
Clearly there are other methods to investing than what is presented here; however, it’s hard to argue the impact of remaining invested or getting in the game today. It’s not generally regarded as a very exciting way to invest, but in most cases you will reap the rewards!
I hope this article has been eye opening for you and you’ve been able to view this topic from a different perspective. Please share any thoughts or feelings you have on this subject. When do you believe is the right time to invest? Has it been beneficial for you?
CERTIFIED FINANCIAL PLANNER™