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Recap of why timing the market is a fool's strategy —plus tips on how to be more successful with your investments
Investing is never a one size fits all approach. Every individual has their own unique styles, preferences, risk tolerance, goals, and financial situation. Different strokes for different folks, right? That’s why investors use different investment strategies, ranging from extremely active to extremely passive.
Both extremes come with their own advantages and disadvantages, but if you are trying to actively trade your investment holdings, you'll want to remove all emotions from decisions. Why? Timing the market properly (both on the buy and the sale) proves time and time again to be impossible. Any financial professional will tell you that trying to time the market is a fool's errand. Bummer, right? Well, not really.
Active trading, although typically riskier than sticking to a passive strategy, can come with success with plenty of education and practice. It’s kind of like the idea of bigger risk (can, but doesn’t always!) equals bigger reward. But, this strategy isn’t for the faint of heart. Let’s dig into why.
The nature of the markets
We look at the markets in two ways: micro and macro.
When we zoom in and look closely at individual equities and shorter timeframes, outcomes become insanely hard to predict and even harder to time. In the bigger picture, though, markets consistently tend to go up over time. This happens no matter what happens day-to-day or to any of the individual stocks. Remember, we're talking big picture here, in aggregate.
Why and how does the market sustain this? Several reasons.
Growth: In the US alone, our GDP has more than doubled since the year 2000. Meanwhile, countries like China have seen 17x in growth in that time frame, and most countries with major stock markets are also continually growing, too. Stock markets are valued at multipliers of their actual revenue, and you can trace this increasing production output directly back to businesses. More production, more profit, higher stock prices, and eventually, higher markets. Inevitably, almost all nations/empires will eventually collapse, but betting on the likelihood of this happening in our lifetimes is straight-up gambling.
Inflation: The amount of currency in circulation increases over time, thereby diluting the value of a dollar and increasing prices. Even if we weren’t printing money, a growing population with more people vying for those same products would increase prices anyway. Currencies must dilute over time, that’s just inevitable. As a result, everything gets more expensive, and stocks are no exception. The difference is that, because stocks trade at often high multipliers, they almost always beat inflation from a long-term, whole market perspective.
Natural selection: The very nature of the stock market is so that it contains the “best” companies to offer to investors. Natural selection “takes care” of the losers by way of things like acquisitions, bankruptcies, or delistings. As a result, the successes stay and end up eating large weightings of major market indexes (or, in other words, the things that track the market’s general upward trek).
The odds of perfect timing
What is there to learn from the nature of the markets? Investing for the long term is a pretty surefire bet—in fact, it's one of the best bets we can make on our financial future.
While trying to time the market may be tempting, especially when you read about economic trends and predictions, the odds are simply stacked against us. It’s like playing chess against a computer.
Although it’s hard to pin down an exact number, it’s widely accepted that:
Only about 1%-2% of active day-traders turn a profit in any given year;
80% of those who gave it a try end up quitting within their first two years; and
40% don’t even last a month.
The returns are even harsher, with the average active trader underperforming the market by about 6.5% in a normal year.
This is a very defeating reality for some, and can often sour individuals on investing forever. Others may turn to alternative asset classes like crypto, lending, or even private equity to try and get a fix, but the odds are even worse elsewhere.
Historically, patience wins
At the end of the day, there is no singular and objectively proper way to invest, and every individual has to craft their own strategy that works for them and their own situation. Understanding this, we can also acknowledge the reality of the data too, and accept that the odds are most in our favor when we invest broadly, over the long run.
This can be a hard pill to swallow, especially during market downturns and crises like we’ve seen this year, which are made to feel even scarier if you’re new to all this and haven’t weathered a bear market before.
Ultimately though, knowledge is our most empowering tool, and learning about the data and history of winning that’s behind a long game type mindset can be a really soothing treatment for anyone’s down market jitters.
Now, pop into the app for your To Do List. And, while you’re at it, take a peek at our flashcards in the Resources section to stay on top of your financial terms. #YouGotThis!