The S&P 500 index returned an average of 8% per year from 1998 to 2008. According to a study conducted by the research firm, Dalbar, investors only averaged 2% annually from 1998 to 2008 though instead of the full 8% because they tried to time the market. Using a buy and hold investing philosophy would have helped investors earn the market average, but the allure of getting rich fast though timing is too seductive for most investors. Many investors also panic when stocks take a dip. They end up buying at the top end and selling at the low which is of course counter intuitive to the age old adage of “Buy Low, Sell High”.
We have seen similar episodes in the most recent market crash as well. People are inherently risk adverse and prone to panic selling when the market takes a dip. Investors showed that they also fibbed on the risk tolerance worksheets and quizzes that we all took in the past before the crash. Most investors said that they could stomach a steep short term decline in stock prices because they were in stocks for the long haul. The recent exodus of money out of the markets has proven that theory wrong. It has proven that we were not truthful to ourselves and our investment advisors. Billions of dollars have been taken out of the stock market at the absolutely worst time, when stocks were down, and sat on the sidelines out of fear when the markets began to rise again.
People find themselves “fighting the tape” and buying and selling their investments at the worst time when they cannot take the swings emotionally. They feel like they are missing out of the market’s eventual upswing as well and pile back into the market chasing the ticket tape. The real problem with timing the market is that you have to be right twice, when you buy and when you sell.
So, what is a good investor to do?
Dollar Cost Averaging. The beauty of dollar cost averaging is that when shares are expensive, you buy fewer of them, and when shares cost less, you buy more. Over time, the costs of your various purchases and the number of shares you own average into what will be a lower cost basis for the shares. Dollar cost averaging will help you keep from trying to time the stock market’s ups and downs. There is no reason to try and time the stock market when you are investing consistently using dollar cost averaging.
Ignoring The Market. Now that the stock market is rebounding off of the recession’s lows, there are a lot of television pundits and writers out there talking about all of the gains recently. The worst thing you can do is stare at the television news following the constant ups and downs of the stock market. If you are a long term investor, the best thing you can do is ignore the stock market. Do not turn on the television, stay away from CNBC (even though they are great), do not read the newspapers (blogs are ok), etc. Take a break from watching the market. Do not check your portfolio balances. Do not see where your stock closed. Ignoring the market will help curb your craving to try and time it.
Practice Timing If You Must. Do you have a great investing idea? Are you just dying to try your hand at timing the market? I can understand the allure of quick riches. If you absolutely must try, I would recommend trying a “stock market” game to practice trading. I have been using UpDown.com for almost a year now to practice trading. You can challenge other people or just play against yourself and the market. The best part about UpDown is that they pay you a portion of their advertising revenues if you can beat the S&P 500 index. This graph is my results over the past few months trading at UpDown. You can see that while I have been close to the index, I cannot consistently beat it.