In a recent Vestact newsletter, reference was made to a study by the Schwab Center for Financial Research which touches on one of the most important factors influencing your investment returns, i.e. when to start investing.
Giving full credit to Schwab, and Vestact for picking up on this study, we provide you with the following summary of the Schwab study:
We ran the numbers on market timing. Our findings? There’s a high cost to waiting for the best entry point.
Imagine for a moment that you’ve just received a year-end bonus or income tax refund. You’re not sure whether to invest now or wait. After all, the market recently hit an all-time high. Now imagine that you face this kind of decision every year—sometimes in up markets, other times in downturns. Is there a good rule of thumb to follow? Our research shows that the cost of waiting for the perfect moment to invest typically exceeds the benefit of even perfect timing. And because timing the market perfectly is nearly impossible, the best strategy for most of us is not to try to market-time at all. Instead, make a plan and invest as soon as possible.
But don’t take our word for it. Consider our research on the performance of five hypothetical long-term investors following very different investment strategies. Each received $2,000 at the beginning of every year for the 20 years ending in 2022 and left the money in the stock market, as represented by the S&P 500® Index. (While we recommend diversifying your portfolio with a mix of assets appropriate for your goals and risk tolerance, we’re focusing on stocks to illustrate the impact of market timing.) Check out how they fared:
- Peter Perfect was a perfect market timer. He had incredible skill (or luck) and was able to place his $2,000 into the market every year at the lowest closing point.
- Ashley Action took a simple, consistent approach: Each year, once she received her cash, she invested her $2,000 in the market on the first trading day of the year.
- Matthew Monthly divided his annual $2,000 allotment into 12 equal portions, which he invested at the beginning of each month.
- Rosie Rotten had incredibly poor timing—or perhaps terribly bad luck: She invested her $2,000 each year at the market’s peak
- Larry Linger left his money in cash investments (using Treasury bills as a proxy) every year and never got around to investing in stocks at all.
Naturally, the best results belonged to Peter, who waited and timed his annual investment perfectly: He accumulated $138,044. But the study’s most stunning findings concern Ashley, who came in second with $127,506—only $10,537 less than Peter Perfect. This relatively small difference is especially surprising considering that Ashley had simply put her money to work as soon as she received it each year—without any pretence of market timing.
Rosie Rotten’s results also proved surprisingly encouraging. While her poor timing left her $15,214 short of Ashley (who didn’t try timing investments), Rosie still earned about three times what she would have if she hadn’t invested in the market at all.
And what of Larry Linger, the procrastinator who kept waiting for a better opportunity to buy stocks—and then didn’t buy at all? He fared worst of all, with only $43,948. His biggest worry had been investing at a market high. Ironically, had he done that each year, he would have earned far more over the 20-year period.
We also looked at all possible 30-, 40- and 50-year time periods, starting in 1926. If you don’t count the few instances when investing immediately swapped places with dollar-cost averaging, all time periods followed the same pattern. In every 30-, 40- and 50-year period, perfect timing was first, followed by investing immediately or dollar-cost averaging, bad timing and, finally, never buying stocks.
In Brief:
- Given the difficulty of timing the market, the most realistic strategy for the majority of investors would be to invest in stocks immediately.
- Procrastination can be worse than bad timing. Long term, it’s almost always better to invest in stocks—even at the worst time each year—than not to invest at all.
- Dollar-cost averaging is a good plan if you’re prone to regret after a large investment has a short-term drop, or if you like the discipline of investing small amounts as you earn them.
- Lastly, it’s important to note that there’s no guarantee you’ll make money through investing in stocks. For instance, there’s always a chance we could enter another period like the 1960s through early 1980s.
