The other day I got a tweet from my brother-in-law Brennan (who’s an awesome guy and runs a travel blog if you’d like to check it out, though you should first make sure to hide the women and children).
Anyways, the tweet looked like this:
This is a really important question because it’s the kind of thing many people worry about when they start investing. As my friend Jason writes, the fear of a market crash is a big reason why many people avoid investing altogether, or simply don’t take advantage of it as much as they should.
But there are two very simple assumptions underneath this kind of thinking, both of which need to be challenged:
- That a market crash is the biggest thing investors have to fear, and
- That you can successfully time your way in and out of the market
We can make quick work of the market timing assumption and will do so below.
As for the 1st assumption, research shows that older investors who are nearing or at retirement age are correct in fearing a market crash first and foremost. Big losses early in retirement can have a significant negative impact on whether their money lasts the rest of their lives.
But for younger investors, the fear of a market crash really needs to be challenged. In fact, the biggest risk we face is not a big market crash, but failing to participate in the big market rallies.
The fear behind market crashes is misguided
For young investors, the primary goal of investing should be growth. We likely don’t yet have the wealth we need for true financial freedom, so our job is to build it.
With that in mind, the focus on market crashes is misguided. It’s not that a market crash can’t hurt, it’s just that it’s not what will hurt the most.
For young investors, the reality is that it’s actually worse to be out of the market when it’s doing well than to be in the market when it’s doing poorly.
The logic is simple. We start with the premise that the market will produce positive returns over the long-term (not a guarantee, but it’s been true so far and otherwise there’s no point to investing at all). With that as our belief, then it leads to the simple truth that the market rallies will be bigger than the market drops.
And if the rallies are bigger than the drops, then the real danger of market timing is in losing out on the growth that those rallies would provide us.
In other words, we can survive the crashes as long as we fully participate in the rallies because the net result will be positive. But once we start missing the rallies, we kill our potential for growth.
And anyways, market timing doesn’t work
I’m going to keep this short and sweet.
There is no credible evidence demonstrating that market timing can be applied consistently and effectively. It doesn’t exist.
Yes, there are examples of successful market timers. There are also examples of lottery winners. The fact that it’s happened to some people through pure chance doesn’t mean it’s a good strategy for anyone else to follow.
On the other hand, there is plenty of evidence showing the very real harm that comes from trying to time the market.
Based on the evidence we have today, the only conclusion we can make is that market timing is only useful if you would like to lower your returns.
How does this information help you invest?
So now we know two things:
- It’s more important for young investors to be in during the good markets than out during the bad ones.
- It is extremely unlikely that we’ll be able to consistently time our decisions to BOTH get out of the market at the right time AND get back in at the right time (therefore not missing the good markets).
So with those two realities, the only logical course of action is to be in the market all of the time.
That doesn’t mean you choose to be 100% in stocks. It just means that you stick with your desired asset allocation no matter what the market is doing. For me, that means that I’ll keep my portfolio split 70/30 between stocks and bonds whether I think the market is overvalued, undervalued or whatever.
Whatever your strategy, the real key to investment success is applying it consistently. People often feel like they have to “beat the market” in order to be successful, but this is simply not the case (see: Why Do You Have to Beat the Market?).
Stay consistent through the ups and downs, keep contributing, rebalance when things get really out of whack, and you’ll likely find a lot of money in your account at the end of it.
So to answer the two questions that started this conversation:
- Is the stock market in a bubble? Honestly, I have no idea and no reliable way to predict it one way or the other.
- If so, when do I sell? When you’re ready to retire (or at least semi-retire) and start living off your investments rather than your income. It has nothing to do with what the market is doing.
How do you react to all the market predictions out there? Would you rather be in during the good markets or out during the bad?
**UPDATE: For anyone who wants to hear a REAL example of how you can benefit big-time from this kind of thinking, check out the comment below from Ree Klein. PERFECT example of what I’m talking about here. Thanks Ree for the contribution!