When there are all kinds of advice and predictions hitting you from every direction, it can be difficult to stay the course and keep your investment strategy in place. Based on the latest doom and gloom from the media, you may be tempted to sell everything and flee to cash. Or you may hear about a hot stock tip and move your money around to try to catch a company on the upswing.
This is called trying to time the market. And it’s usually a mistake.
Especially in periods of market volatility, trying to time the market may seem like a good strategy to increase gains and minimize losses. But if you’re timing the market you’re reacting to predictions, and predictions are frequently way off the mark. Instead of buying low and selling high, chances are you’ll end up buying high and selling low.
The Negative Effects of Market Timing
There has been a lot of market volatility during the past two decades, between the dot-com crash in 2000, the financial crisis in 2008, and today’s constant uncertainty. Many people lost money during these downturns, but the people who lost the most are those who didn’t stay invested and instead fled to the sidelines.
Investors who don’t stay invested during periods of market volatility often miss out on the recovery, and this can torpedo their long-term returns.
According to a study by JP Morgan Asset Management, an investor who bought into the S&P 500 in 1993 and stayed invested through 2014 would have achieved an average annualized return of 9.85%. If they fled to the sidelines and missed the ten best days in the market during this period, their annualized return would have dropped to just 6.1%.
To put that in real terms, if you invested $100,000 in 1993 and kept it in the market, you would have $789,953 at the end of 2014. But if market timing caused you to miss the ten best days, you would only have $367,907.
The Buy and Hold Approach
The above is an example of how reacting to the market can have a very negative effect on your returns over the long run. The market will always go up and down, and the path to long-term success is staying focused on your goals and staying invested with the proper asset allocation.
This is called the buy and hold approach. This strategy focuses on finding high-quality investments that are suitable for you and your financial goals and holding them for the long-term.
To execute a buy and hold strategy, work with your advisor to:
Determine the appropriate mix of stocks and bonds based on your appetite for risk, your financial goals, and your time horizon.
Select a model that fits within your target allocation, which will be composed of high quality, low-expense investments.
Rebalance back to your target allocation as needed.
Stay the course and make adjustments according to your plan.
The buy and hold approach is simple, but it’s not easy. It is easy, on the other hand, to get caught up in the latest news item or investing fad and let them blow your ship off course. But achieving your financial goals takes a steady hand and an eye on the horizon.
Quality Investments For the Long Term
Think of your portfolio as a house. When you buy a house, you want to make sure it is well constructed and has a solid foundation. After all, it’s more than an investment, it’s an asset that will pay you dividends of happy living for many years. But if the value drops 10% next year are you going to turn around and sell it? How about if it goes up 30%?
Your house is there to provide you with a place to live and raise your family, and like your portfolio, the value will fluctuate from year to year. But the only time the value of your house matters is when you intend to sell it. As long as it’s a quality house with a strong foundation, your decision to sell should be based on your long-term goals, not short-term market fluctuations.
It’s much the same with your portfolio. If your portfolio has a strong foundation of high-quality investments with the proper asset allocation, you’re better off staying invested and focusing on your long-term goals than reacting to every dip and rise in the market.