One of the biggest roadblocks to financial success is your own behavior, or cognitive biases that get in the way of rational thinking.
It doesn’t matter if you’re extremely intelligent, talented, and successful. It doesn’t matter if you’re an experienced investor or a total beginner — we all face the challenge of managing our own decision-making process and the actions that stem from it.
Case in point: the fact that plenty of smart, successful people with cash to invest for the long-term are currently refusing to invest it.
As a financial advisor, I see this all the time.
I’ll have a client come to me and say, “you know, I have this cash sitting in my savings account and I know how important it is to invest so I can take advantage of compound returns…
…but the market is going to crash soon, so I’m going to wait.”
This is called timing the market, and it’s one of the fundamental mistakes even experienced investors make that causes them to miss opportunities — or worse, lose money.
The Trouble with Market Timing
On the surface, this train of thought seems pretty reasonable. We’re all dealing with the same basic facts about the current market:
- It’s been one of the longest bull markets in history
- It just keeps going up.
- It can’t go up forever.
Those are all true statements and using these facts might be part of a rational decision-making process.
The problem is when you throw in one final statement to that list: “it’s going to crash soon.”
That is not a fact. But it is negativity bias at work, or the irrational way of thinking that causes people to put more emphasis or give more weight to bad news than good.
This can feed into another bias: confirmation bias, which encourages people to seek out information that confirms their (negative) suspicions. And, that’s not very hard to do if you consume news about the financial markets.
Keep in mind that financial media and TV programming about those financial markets doesn’t exist to give you good advice.
It exists to create content, which serves the purpose of getting more clicks, more reactions, and more viewership (which translates into more ad dollars and therefore more profit).
But the belief or assertion that the market will crash in the very near future is just that: a belief. To be more accurate, it’s speculation.
Anyone who says they know when the next market correction will happen is guessing at best. At worst, they’re downright fabricating.
Absolutely no one can predict what the stock market will do next. It’s worth repeating: anyone who thinks they can do it is speculating, guessing, or forecasting. Period.
Yes, the Market Must Crash Eventually… But No One Knows When “Eventually” Is
Again, you’re being pretty smart and reasonable to think “what goes up must come down” when it comes to the stock market. You’re absolutely right: it will crash.
And no one knows exactly when “eventually” is or what it looks like.
It could happen tomorrow. Or it could happen in 2 years. Maybe it won’t happen for another 5. The point is that we don’t know.
But most people’s aversion to loss keeps them from simply taking the cash they have sitting on the sidelines and investing it. The fear that tomorrow is that “eventually,” which could cause them to lose what they just invested, keeps many from taking action.
There’s the problem: what if it does take 2 more years before we see a market correction?
That whole time, you would be sitting on your cash, refusing to invest, because you thought that correction was going to happen “any day now.”
That means you could have incurred massive opportunity costs because you missed those 2 years of potential growth as the market continued to climb upward. And when you do buy in, you’ll be buying at an even bigger peak than the one you thought you were avoiding.
This isn’t just a hypothetical scenario.
Just take a look at this article from March 1, 2015, that ran on Marketwatch and contained such dire warnings as to almost read as satire when you look back on it today.
It included lines like this “the Crash of 2016, one that promises in the end to become bigger and badder and far more dangerous than 2008, 1999 and 1929 combined..”
In fact, this writer was so confident that he opened the entire article by saying, “It’s time to start the countdown to the crash of 2016. No, this is not a prediction of a minor correction. Plan on a 50% crash.”
I don’t know if you can remember back to 2016, but the S&P 500 returned 11.9% that year. Not exactly what I’d call a crash… much less a loss of 50% of the stock market’s value.
And yet we still see articles showing how 58% of investors think the bull market is on its last legs and 2018 is the peak.
Maybe. Those investors could be right.
Or they might end up being as wrong as the doom-and-gloom forecasters of 2016, who ended up looking extremely foolish since the market didn’t just avoid a crash — it hit all-time highs between 2016 and today.
What If You Always Invested at the Worst Possible Time?
This is all well and good, you might say. But what if this is finally the time the speculators guessed correctly?
That’s a valid fear. After all, chance says they have to be right eventually (not through their own skill at making predictions, but by the simple fact we can all agree on: the market will go down at some point).
But even if that happened — even if you invested your cash today and the market tanked tomorrow — you are likely better off making the investment than continuing to sit on the sidelines and miss out on time in the market if your goal is long term growth.
Because that’s what investing success is really all about: time in the market. Not market timing.
Don’t believe me? You don’t have to: you just need to look to the case study Ben Carlson of A Wealth of Common Sense created to show what actually happens in this very scenario.
Meet Bob, the “World’s Worst Market Timer.” Bob does exactly what you think he would from that kind of title: he consistently invests at the absolute peak of the market, just before it suffers some of the worst crashes in its history.
Bob is pretty much your worst nightmare if you’re sitting on cash thinking “I’ll wait to invest because I don’t want the market to crash right after I contribute to my portfolio.”
From 1972 to 2007 he only invested in the market in the months before major market crashes:
- in 1972, right before the market fell almost 50% in 1973
- in 1987, when it crashed again and lost 37%
- right at the end of 1999 just in time to see the market lose almost half its value again
- in 2007, when the Great Recession delivered a 52% loss
Surely, Bob is broke, destitute, and living in a cardboard box on the side of the road thanks to his awful decisions about when to invest — right?
You might think so, but you’d be wrong.
It’s Not About Market Timing. It’s About Time in the Market
In this scenario, Bob invested $184,000 in cash from 1972 to 2007. And what did he end up with in 2013?
How did Bob do it? The catch is that while he invested at the worst possible times, he never sold any of his positions. He invested on those 4 days, but never pulled his money out of the market.
Could he have had even more money if he chose different days to invest? Sure.
But the original scenario set out to answer the question, “what happens if you invest cash right before every major market crash throughout your working career?”
The answer is you’d still be a millionaire in this example.
So rather than worrying about market timing, focus on is setting up a systematic way to invest money so you make strategic, rational decisions and don’t fall victim to cognitive and emotional biases that cause you to make silly investment choices.
Often, that systematic way of investing is dollar cost averaging.
(Another look at Bob’s situation, by the way, showed what would have happened had he used dollar cost averaging instead of trying to time the market. Had Bob done this with his $184,000, he would have turned it into $4.4 million.)
Worrying about investing right before a market peak is a valid concern, and it’s also distracting you from what really matters. It’s far more important to find systems and processes to help you manage your own behavior so you can invest with greater success.
Myth: “Financial Advisors Are For Rich Old White People”
FACT: Beyond Your Hammock believes financial advice should be for you when you’re young and crushing it in your career — but before you’re wealthy. We think you should know how to actually make the right moves to grow your net worth now. Here’s what else we believe financial planning should do differently for people like you.