After I went on TV recently saying that investors should try to fight the urge to do something amid the first stock market correction in nearly four years this past summer, I received an angry email from a viewer who questioned this advice. He believed that the market sell-off was just the tip of the iceberg and that investors should bail out of all stock holdings.
While many investors believe they can time the market, there is ample evidence that it does not work. According to an analysis by the research firm Dalbar, the 20-year annualized return (through 2014) for the average equity mutual fund investor was 5.19 percent, compared with the 20-year annualized Standard & Poor's 500 return of 9.85 percent. Investors lagged the index by a whopping 4.66 percent annually. Dalbar reports that the biggest reason for underperformance is psychology, highlighted by investor panic selling at the bottom and the lure of following short-term market trends. Dalbar CEO Louis Harvey says the idea that an investor can generate market-beating returns through proper timing is "totally fictional."
Perhaps my emailer was different and he could figure out how to time the market, but I am dubious. Consider this: If you had sold all of your stocks during the first week of the financial crisis in September 2008, you would have been shielded from another 40 percent or more in further losses. (Stocks bottomed out in March 2009.) Sounds great, but how would you have known when to get back in?
Most investors, from seasoned pros to mere mortals who are saving for retirement, lack the guts or lucky timing to buy when stock indexes seem like they are hurtling toward zero. As a result, even if you made a decent sale in the fall of 2008, you most likely would not have bought the rock bottom in March 2009 and you may have missed a large portion of the near tripling in value of the indexes from the lows. In essence, market timing requires two nearly impossible decisions: when to get out and then when to get back in.
The opposite of those panic-induced sell orders are those who fear buying at the top of the market, which is often the rationale for many who can't pull the trigger on an investment. There's good news here as well: Dan Wiener, editor of The Independent Adviser for Vanguard Investors, points out that the investor who had the bad luck of buying the Vanguard 500 Index Fund on the Friday before Black Monday (Oct. 19, 1987) when the fund dropped 20.5 percent in a day, did just fine, provided he didn't panic and sell. In fact, Wiener said, "he would have had a gain of 2.1 percent one year later, and a total gain of 19.3 percent three years later."
Wiener has conducted stock market research dating to 1927 in order to weigh investor performance based on time in the market, rather than the fantasy of market timing. He found that for those who invest for a single day, the chance of losing money is 46 percent, but for those who invest with a 10-year investment horizon the chance of success improves dramatically -- to 87 percent.
Despite fielding an angry email or two, my advice to stay put and not be reactive puts me in good company. John Bogle, founder of The Vanguard Group, wrote this about market timing: "After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I don't even know of anybody who knows anybody who has done it successfully and consistently." And then there's one of my favorite Warren Buffett comments: "I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two."
Bottom line: Stick to your plan!