Investors have a wide range of potential vehicles through which to grow their savings. Among the basic asset classes of stocks, bonds and cash, the clear winner historically has been the stock market, producing long-term returns far in excess of bonds or cash.
But investing in stocks requires a suitable temperament, given the inevitable ups and downs that market cycles generate. Since it is well established that attempting to time the market is a fool's errand, successful investors must possess the fortitude to ride out the swings and resist the destructive temptation to jump in and out. Stock investing isn't for sissies, constitutionally speaking. But history has shown the rewards to be superior for those who can tolerate the volatility and stay invested over time.
Christopher HopkinsBegin with the premise that market cycles are inevitable and unpredictable, and that the shorter the time frame the less predictable the result. Naturally, we would like to improve the odds a bit by avoiding big declines and capitalizing on large gains. But experience shows that it is virtually impossible to sufficiently polish up the crystal ball and that the cost of erring is higher than the potential benefit of timing.
Numerous academic studies have looked at the theoretical benefits of market timing if it could be done effectively. One of many was authored by the fund firm Invesco, looking at stock returns since 1927. Consistent with other research, the Invesco paper estimates that missing just the best 10 days over that 88-year period would have cut your total return by two thirds. And perhaps more significantly, being out of the market for the 10 worst days in 88 years would have tripled your gain. The astute observer recognizes that a timing method to avoid the downers and enjoy the gainers would improve the results dramatically.
Problem is, it can't really be done. Most of the best and worst days occurred during falling market cycles. Furthermore, they tend to cluster together; a good day follows closely on the heels of a bad one, so that almost any attempt to avoid a big decline is almost sure to miss out on a concomitant rally. Investors that attempt to time the market almost always lag the steady Eddie who commits and stays the course over the long term.
Cyclical swings are inevitable in the stock market; in fact, the potential for short-term losses is essentially the reason the market rewards longer-term investors: to compensate for risk.
The U.S. stock market tends to experience a decline of at least 10 percent about every two years. These shallow contractions are called "corrections", and should be ignored by investors with the proper perspective as they are typically short-lived and impossible to predict.
Deeper pullbacks of 20 percent or more are referred to ominously as "bear markets," occurring less frequently and lasting somewhat longer. Still, investors searching for the holy grail of market timing to avoid these setbacks have been sorely disappointed.
According to data from Yardeni Research, the S&P 500 index has experienced a total of 19 bear markets and 27 corrections since 1928. That implies that the market has been in a bear or correction phase about 40 percent of the time. And yet, an investor with the foresight to bet $1,000 on the S&P 500 88 years ago and let it ride with reinvested dividends would have accumulated $168,000 today despite the volatility.
Stock investing is not for everyone. Successful investors understand the benefits of time and the virtue of patience. But the rewards are worth it.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.