When is it a good time to buy stocks? For the savvy investor the answer is “when stocks are cheap.” After all you want to buy low, sell high. But how do you know when stocks are cheap? How do you know when they’re expensive? The ability to buy low and sell high is easier said than done. Trying to determine the best times to buy and sell stocks is called market timing, and I’m here to tell you that market timing is stupid.
If you knew the stock market was going to crash next month, you would probably not invest in stocks right now. Knowing that the stock market traditionally always goes up eventually, you would wait until after the crash then invest in stocks. On the other hand, if you knew that the market was going to skyrocket next month, you would be socking away all the money you could in order to ride the wave upwards. If only we knew in August of 2019 that in 2 years Tesla would increase by over 2000% and Elon Musk would be worth more than Bill Gates and Warren Buffett combined!
The problem, of course, is that no one knows what the stock market is going to do tomorrow, much less months or years from now. If you were able to know then you could be worth more than Bill Gates and Warren Buffett combined.
Fancy Guestimation
The closest thing we have to knowing the future is data analytics. Based on past performance and future estimates, market analysts can guess where the market is going next. But that’s all these are: a guess. Several big-name firms have published their guesses for how the S&P 500 will look at the end of 2022 based on their own models and data analytics. As it stands right now, the S&P 500 is at about 4500.
| Investment Firm | S&P 500 Prediction for the end of 2022 |
|---|---|
| Wells Fargo | 5,100-5,300 |
| Goldman Sachs | 5100 |
| J.P. Morgan | 5050 |
| Bank of America | 4600 |
| Morgan Stanley | 4400 |
The first thing you’ll notice here is that the spread is a whopping 900 points. That corresponds to a 20 percentage point different between Wells Fargo and Morgan Stanley! That’s a big difference considering the long-term average for the S&P 500 is 7% increase per year.
So how do five well-respected firms come up with such a large spread in possible values? They’re all using the same data. All the information is published and accessible to the public. It has to be public because insider trading is illegal. So why aren’t these predictions more or less the same? The answer is they’re all just guessing.
The function of economic forecasting is to make astrology look respectable.
John Kenneth Galbraith
So What do I do With This Information?
What does this have to do with market timing being stupid? Well what if Wells Fargo or Goldman Sachs is correct and the stock market increases by 13%-18%? That would be great I’d put all of my money in the S&P 500. But what if BofA or Morgan Stanley is correct and the stock market stays flat for the year or worse goes down? You’re less eager to throw your life savings into the stock market.
Some people borrow money to invest. This is called “margin” and is a bad idea for the following reason. Let’s say you think Wells Fargo is correct and the market is going up up up. You’re so set on this that you borrow a large sum of money and use it to invest in the market. If you make gains on that money then you can pay off your loan with the gains you’ve made and keep the extras.
But let’s say instead Wells Fargo was too optimistic and instead the S&P 500 falls to 4200. Not only have you lost money in the stock market, you lost the money you borrowed. Now you’re in hot water when the bank comes calling on its debts. Never invest money you don’t own. Remember, the Wells Fargo analysts don’t know what the market will do. If they did they would be the richest people in the world rather than Elon.
But what about the other option? Instead of Wells Fargo, let’s say you think Morgan Stanley has the right idea and the market is going to drop. You’re afraid of a market crash so you stop investing and you pull all your money out of your 401(k). You don’t want to lose your life’s savings so you conservatively stuff that cash in your mattress.
Let’s say after you do this the S&P 500 does hit 5300. You’ve just lost out on 18% gains. And now you have a large sum of money that you have to decide what to do with. Do you put it back into your 401(k) and invest it in the market? You’ve already missed that 18% gain, maybe the market will drop 11% next year to correct to it’s 7% annual average? do you risk investing in the market now or play it safe another year?
Market Timing can be Paralyzing
You can understand how market timing can be paralyzing. Waiting for the perfect time to invest in the market will leave you old and poor. Either stocks are overvalued and it’s not a good time to invest or stocks are crashing and it’s not a good time to invest.
People have been saying since 2017 that the stock market is overvalued and is due for a correction. A correction happened in December of 2018 when the market dropped about 12%. But if you waited for that to happen you would have lost out on 2017’s 19% gain. The desire to wait for a crash would have meant a loss of 7% compared to just investing when you had the money.
Or what if you noticed that the world was starting to be afraid of a novel coronavirus in February 2020. Between February 21st and 28th 2020 the S&P 500 dropped 12%. As a savvy investor I decided to “buy the dip” and invested a chuck of change during that time. What happened next? The S&P went down another 22%. Well that felt dumb. You can see how market timing very rarely works out favorably.
Luckily for me the stock market shot back up from its March lows and I made some money. But looking back on it now I would have made just as much, if not more, if I had just invested that money a couple months prior in 2019 rather than wait for a market correction.
How do I invest?
The point is no one knows what the future holds. Not you, not me, not J. P. Morgan. Only God is Omniscient so we must invest accordingly. We invest in broad market index funds like a total stock market index fund or an S&P 500 index fund because the market generally goes up over time. There are dips and corrections, but statistically the market increases by about 7% every year. And if we’re investing for 40 years those dips and corrections will hardly register on the radar. And if a total market index fund does go to zero it means the world has ended and you have more important things to worry about like where you’ll spend eternity.
The market could go up or down, but since we’re confident it will statistically keep going up, it doesn’t matter when you invest, it only matters that you do invest. An old adage says, “The best time to invest was yesterday, the next best time is today, and the worst time is tomorrow.”
The best time to invest was yesterday, the next best time is today, and the worst time is tomorrow.
A market crash is coming. It may be soon or still far off. It’s possible the new Omicron Covid variant may prompt countries to shut down and cause stocks to tumble. Or maybe we’ll see another decade-long bull market. We don’t know what will happen so don’t try to time the market.
Conclusion
Market timing is stupid since we don’t know the future of the stock market. But how do we prudently invest without risking our entire life savings? The answer is dollar cost averaging which I’ll explain in the next article.
What you do think? Not knowing the future, how do you invest? Let us know in the comment below.