Time In The Market vs. Market Timing
Investing is confusing and risky right? You need to do a ton of research to make sure that you’ve picked the perfect investment. The timing isn’t always right. What if things go wrong!? Analysis paralysis is the comfortable hole to fall into, just sitting on the sidelines with cash in hand, not exactly sure what you should be doing or when. At least you can’t lose your original money this way…
Guess what? You are still investing while you wait! Your chosen investment vehicle is cash, which has been specifically designed by your government to have a negative 2% return per year. This past year (2021) the average inflation in the US (the amount by which your money is reduced in purchasing power each year) was over 7%.
Hold up. Just by waiting things out, unsure what you should be doing, you actually invested and the result was a -7% return. That’s what the kids call taking a big L.
Maybe you justify this by telling yourself that you are waiting for a big dip in the markets to buy in, at which point the money that’s been eaten away from inflation will be worth it when you nail the timing. But here’s the thing - time in the market beats market timing pretty consistently. Don’t trust me, trust the people who research this stuff.
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” - Peter Lynch, one of the most consistently successful investors of all time.
No one knows exactly when the market ups and downs will happen. Trying to avoid the down days also ensures that you miss the gains. Risk avoidance is risky.
Ok so maybe you're feeling anxious at this point because you still don’t know what to do and you’ve also seen that waiting is costing you big as well. So how do you get out of the cycle of doing nothing? There are a few approaches that will allow you to sleep soundly at night, knowing you are building long term wealth sustainably.
How To Invest At The Right Time (Spoiler: Don't Try)
Let’s go through a few reasonable ways to enter the market, assuming you start with $1000 in cash that you’re willing to invest 👇
Lump Sum
Simple. Dump all your investable cash into the market at once, as soon as possible. Psychologically, this is hard. Logically, this is usually a good move because markets go up over the long term. If you can manage to fight the natural urge telling you not to do this, great! You are mentally strong and will likely be rewarded for it.
✅ Example: we invest the entire $1000 right away.
Dollar-Cost Averaging (DCA)
If you're feeling uncertain about putting all of your savings into the market at once, start with 20% of it. After a month, invest another 20%. Do it again in 2 months. Keep putting in the same amount periodically. Repeat until you’re fully invested. This is a way to make you feel more comfortable psychologically. Note that the 20% and monthly periods here are completely arbitrary. This could be any amount you are able to consistently contribute - you could just as easily do 1/30th for every day in a month. Taking less time to enter the market is better, all things considered, because of the time value of money.
✅ Example: we might invest $200 (20% of $1000) on the first day of every month until we’re fully invested after 5 months.
Value Averaging (VA)
Here’s an approach that might make your logical (but anxious) brain happy. The idea of Value Averaging is similar to Dollar-Cost Averaging except that you buy more shares when prices are falling and buy fewer shares when prices are rising. Buy low, sell high - jah feel?
✅ Example: we want to invest our $1000 over 5 months, as in the DCA example above where we put $200 in each month. Using Value Averaging, we would aim to have a total investment value of $200 at the beginning of the first month, $400 at the beginning of the second month, and so on. So we invest $200 at the beginning of the first month. Imagine that our investment is worth $205 at the end of that month. In that case, we now invest $195 more to reach the second month target of $400. If at the end of the first month, the original investment is worth $405, we’d withdraw $5 so that our total invested value is $400. We repeat this so that the third month total invested value is $600. Keep going until our $1000 is fully invested.
So which approach is best?
All of these approaches are reasonable. In certain circumstances, one will beat the others. There is no proof that one will always be best so choose the method that you can stick with consistently.
What happens if my investment tanks while I’m in the process of entering the market?
If you see any big market drops during these processes, don’t freak out! Definitely don’t sell the assets you just bought. After all, a market correction means stocks are on sale. The best thing you can do in that scenario is actually to buy more. If you have a long term investment horizon, this is just an opportunity to buy more at a lower price.
The Bottom Line
The concepts we’ve gone through here can be hard to wrap your head around. A key takeaway though is that amount of time in the market is one of the biggest determinants of your investment success. Even if it turns out that you’ve invested at the worst possible times, you’d still end up with more in the long term than if you had not invested at all. It’s easy to always feel like you are investing at the top - that’s because the stock market is usually at an all time high!
There is no reason for holding a lot of cash. If you’re making a large purchase in the next few months, at least put the money in a high-interest savings account (HISA) that will net you a few percent annual return with no lock up. You’ll counter the effects of inflation right now and with interest rates rising, you might see the HISA rate increase in the near future. If you are saving for the long term, use one of the methods we went through to enter the market as soon as you can.